House Price Booms and the Current Account

Abstract

A simple open economy asset pricing model can account for the house price and current account dynamics in the G7 over the years [2001][2002][2003][2004][2005][2006][2007][2008]. The model features rational households, but assumes that households entertain subjective beliefs about price behavior and update these using Bayes' rule. The resulting beliefs dynamics considerably propagate economic shocks and crucially contribute to replicating the empirical evidence. Belief dynamics can temporarily delink house prices from fundamentals, so that low interest rates can fuel a house price boom. House price booms, however, are not necessarily synchronized across countries and the model correctly predicts the heterogeneous response of house prices across the G7, following the fall in real interest rates at the beginning of the millennium. The response to interest rates depends sensitively on agents' beliefs at the time of the interest rate reduction, which are a function of the prior history of disturbances hitting the economy. According to the model, the US house price boom could have been largely avoided, if real interest rates had decreased by less after the year 2000.JEL Classifications: F41, F32, E43

House price dynamics: Fundamentals and expectations

“…For example, see Adam, Kuang and Marcet (2011) for an open economy asset pricing model, Burnside, Eichenbaum and Rebelo (2011) and Peterson (2012) for matching models. 2 2 for the growth rate of dividends we obtain a fundamental solution for the price-rent ratio that matches the sample average over the sample 1987-2011.…”

“…The choice of such a stylized model is justi…ed by the fact that this framework allows us to clearly isolate the contribution of expectations alone from other mechanisms that could a¤ect house prices. 1 Also, Lucas tree type models or simple present value models have been used in the …nance and real estate literature to characterize house price movements. 2 We explore the ability of four variants of this model to match the data.…”

House Price Dynamics: Fundamentals and Expectations

“…Solving the model under rational expectations and assuming an autoregressive process 1 Recent macroeconomic studies are assessing the role of non-fully rational expectations in conjunction with other factors for the dynamics of housing prices. For example, see Adam, Kuang and Marcet (2011) for an open economy asset pricing model, Burnside, Eichenbaum and Rebelo (2011) and Peterson (2012) for matching models.…”

Trend growth expectations and U.S. house prices before and after the crisis

“…From an asset pricing perspective, the observed increase in price-to-rent ratios during the boom phase can in principle be justified either by a decline in the discount rates with which future rental income is being discounted, or by the anticipation of future capital gains. To generate the latter, some form of extrapolative expectations about future house prices has been suggested (Shiller, 2007;Adam, Kuang, and Marcet, 2011 mechanism in which households form expectations that are governed by a perceived law of motion for house prices which ex-post is confirmed by the actual law of motion.…”

“…In terms of economic theory, while the simulations explain most of house price changes as the outcome of rational behavior and unchanged financial parameters, the episode since 2005 poses new questions. The decoupling of actual house prices from the values implied by our model may be on the one hand due to departures from rationality, such as some form of exuberance setting in, or bubbles building up along the lines of Adam et al (2011) or some yet to be specified mechanism. How this works in detail must be left to future research.…”