What Explains House Price Booms

Keeping to the theme from last week, there’s a new paper on house price booms in the latest NBER working paper roundup (abstract):

What Explains House Price Booms?: History and Empirical Evidence
Michael D. Bordo, John Landon-Lane

In this paper we investigate the relationship between loose monetary policy, low inflation, and easy bank credit with house price booms. Using a panel of 11 OECD countries from 1920 to 2011 we estimate a panel VAR in order to identify shocks that can be interpreted as loose monetary policy shocks, low inflation shocks, bank credit shocks and house price shocks. We show that loose monetary policy played an important role in housing booms along with the other shocks. We show that during boom periods there is a heightened impact of all three “policy” shocks with the bank credit shock playing an important role. However, when we look at individual house price boom episodes the cause of the price boom is not so clear. The evidence suggests that the house price boom that occurred in the US during the 1990s and 2000s was not due to easy bank credit. Loose monetary policy (as well as low inflation) played some role but the residual which may be picking up other factors such as financial innovation and the shadow banking system is the most important shock. This result is robust to many alternative specifications.

There’s also a companion paper, looking more broadly at the role of monetary policy in asset price booms (not just housing, but also stocks and commodities), from the same authors (link here).

From a methodological perspective, my greatest criticism would be leaving out house price increases that didn’t have consequent busts (defined in the paper as a 25% correction in price increases during the expansion phase). While that’s understandable in the context of what the paper is trying to achieve, I think such “negative” information would be just as useful from the policy perspective i.e. distinguishing booms that will bust from booms that won’t.

One last note: “loose” monetary policy in this paper is not the same as low interest rates. The definition used here is the difference between policy interest rates and a generic Taylor rule, which produces an “optimal” policy rate:

i^* = π_t + r^* + 0.5(y_t - y_t^*) + 0.5(π_t - π^*)

where:

i^* – the optimal policy rate;
π_t – the current rate of inflation;
r^* – the equilibrium real interest rate;
(y_t - y_t^*) – the difference between current and optimal income i.e. the output gap (in percent of GDP);
(π_t - π^*) – the difference between actual and desired inflation

You would therefore only have loose monetary policy if (i_t - i^*) is negative.

You can have very low policy interest rates, but a monetary policy that is still too tight (e.g. the US) or high policy interest rates, but a monetary policy that is too loose (e.g. India).

Technical Notes

1. Bordo, Michael D. & John Landon-Lane, "What Explains House Price Booms?: History and Empirical Evidence", NBER Working Paper No. 19584, October 2013
2. Bordo, Michael D. & John Landon-Lane, "Does Expansionary Monetary Policy Cause Asset Price Booms; Some Historical and Empirical Evidence", NBER Working Paper No. 19585, October 2013