* We thank seminar participants at the Bank of Finland, London School of Economics and the London MMF conference. We thank the participants for their helpful comments. We are particularly grateful to Michael Ehrmann, Charles Goodhart, Nobuhiro Kiy otaki, Francois Ortalo-Magnè and Jouko Vilmunen for their suggestions. All remaining errors are ours.
We analyse the impact of financial liberalization on the link between monetary policy and house prices. We present a simple model of a small open economy subject to credit constraints. The model shows that the higher the degree of financial liberalization is, the stronger is the impact of interest rate shocks on house prices. We then use vector autoregressions to study the role of monetary policy shocks in house price fluctuations in Finland, Sweden and the UK, characterized by financial liberalization episodes over the last 20 years. We find that the response of house prices to interest rate surprises is bigger and more persistent in periods characterized by more liberalized financial markets.
IIn the last three decades or so, many industrialized countries have experienced wide changes in house prices. It is generally felt that monetary policy conditions have been an important factor behind house price inflation and deflation. It is also agreed that the process of financial liberalization can have played a direct role in these fluctuations (International Monetary Fund, 2000) but little is known, instead, on the possible indirect role that financial liberalization could have had modifying the sensitivity of house prices to monetary policy actions. This paper takes a preliminary step in investigating this issue. In the first part of the paper we present a simple theoretical model of a small open economy subject to credit constraints. With the help of numerical calibrations of the model, we analyse the impact of interest rate shocks on house prices in regimes characterized by different levels of financial liberalization. The results show that the higher the degree of financial liberalization of the economy is, the higher is the impact of monetary policy shocks on house prices.
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