Low Interest Rates and Housing Booms: The Role of Capital Inflows, Monetary Policy and Financial Innovation

Abstract

A number of OECD countries experienced an environment of low interest rates and a rapid increase in housing market activity during the last decade. Previous work suggests three potential explanations for these events: expansionary monetary policy, capital inflows due to a global savings glut and excessive financial innovation combined with inappropriately lax financial regulation. In this study we examine the effects of these three factors on the housing market. We estimate a panel VAR for a sample of OECD countries and identify monetary policy and capital inflows shocks using sign restrictions. To explore how these effects change with the structure of the mortgage market and the degree of securitisation, we augment the VAR to let the coefficients vary with mortgage market characteristics. Our results suggest that both types of shocks have a significant and positive effect on real house prices, real credit to the private sector and real residential investment. The responses of housing variables to both types of shocks are stronger in countries with more developed mortgage markets, roughly doubling the responses to a monetary policy shock. The amplification effect of mortgage-backed securitisation is particularly strong for capital inflows shocks, increasing the response of real house prices, residential investment and real credit by a factor of two, three and five, respectively.

Global liquidity, house prices and policy responses

“…Although we have found global liquidity to impact house prices, the question arises whether it is sufficiently large to weaken the effectiveness of domestic policy in the presence of increased 16 For a detailed analysis of the impact of monetary policy on house prices see Sa et al (2011).…”

“…Countries have adopted different policies at different times. Indeed, monetary authorities may respond to house price pressure by raising their short-term rates to make financing more costly and thus control credit growth (Sa, Towbin, and Wieladek, 2011). To tackle the growth of bank credit triggered by the funding channel, countries may adopt policies directly targeted at the local banking sector, thereby increasing the cost of lending and banks' resilience to financial stability shocks.…”

ABS inflows to the United States and the global financial crisis

“…For discussions of the role of U.S. interest rates in the runup to the crisis, see, among others,Taylor (2008),Dokko et.al. (2009), Glaeser, Gottlieb, and Gyourko (2010), andSa, Towbin, and Wieladek (2011). For analysis of subprime lending and securitization, see, among others,Coval, Jurek, and Stafford (2008),Gerardi, Lehnert, Sherlund, and Willen (2008),Mayer, Pence, and Sherlund (2009),Acharya and Schnabl (2010),Demyanyk and Van Hemert (2009),Kashyap, Rajan, and Stein (2008),and Ashcraft, Goldsmith-Pinkham, and Vickery (2010).…”

Does Macro-Pru Leak? Evidence from a UK Policy Experiment

“…34 SeeGoodhart and Hoffman (2008), Lzzetzki, Mendoza and Vegh (2010) orTowbin and Weber (2010) for an application of this approach. 35 See Assenmacher-Wesche and Gerlach (2010) andSa, Towbin and Wieladek (2011) for an application of this approach in the panel VAR context.…”