Time-varying role of macroeconomic shocks on house prices in the US and UK: evidence from over 150 years of data

Abstract

In this paper, we study the effect of macroeconomic shocks in the determination of house prices. Focusing on the U.S. and the U.K. housing market, we employ timevarying Vector Autoregression models using Bayesian methods covering the periods of 1830-2016 and 1845-2016 respectively. We consider real house prices, output growth, short-term interest rates and inflation as input variables in order to unveil the effect of macroeconomic shocks on house prices. From the examination of the impulse responses of house prices on macroeconomic shocks, we find that technology shocks dominate in the U.S. real estate market, while their effect is unimportant in the U.K. In contrast, monetary policy drives most of the evolution of the U.K. house prices, while transitory house supply shocks are unimportant in either country. These findings are further corroborated with the analysis of conditional volatilities and correlations to macroeconomic shocks. Overall, we are able to unveil the dynamic linkages in the relationship of the macro economy and house prices. Over time, we analyze the variations in economic events happening at the imposition of the shock and uncover characteristics missed in the time-invariant approaches of previous studies.

Macroeconomic Shocks and Changing Dynamics of the U.S. REITs Sector

“…While there exists a large number of studies that have analyzed the role of both conventional and unconventional (in the wake of the zero lower bound (ZLB) scenario) monetary policy [3][4][5][6][7][8], and more recently, fiscal policy shocks on real estate markets [9,10], and the feedback from it in shaping policy decisions, there is dearth of studies that have analyzed the role of aggregate demand, aggregate supply, and bond yield spread shocks on real estate markets. The only exception to this is the recent paper by Plakandaras et al [11], where the authors study the effect of macroeconomic shocks in the determination of house prices in the US and the UK by employing time-varying parameter vector autoregressive (TVP-VAR) models covering the historical annual periods of 1830 to 2016 and 1845 to 2016, respectively. From the examination of the impulse responses of house prices on macroeconomic shocks, Plakandaras et al [11], found that technology shocks dominate in the U.S. real estate market, while their effect is unimportant in the U.K, where, monetary policy shocks drives most of the house price evolution.…”

“…The only exception to this is the recent paper by Plakandaras et al [11], where the authors study the effect of macroeconomic shocks in the determination of house prices in the US and the UK by employing time-varying parameter vector autoregressive (TVP-VAR) models covering the historical annual periods of 1830 to 2016 and 1845 to 2016, respectively. From the examination of the impulse responses of house prices on macroeconomic shocks, Plakandaras et al [11], found that technology shocks dominate in the U.S. real estate market, while their effect is unimportant in the U.K, where, monetary policy shocks drives most of the house price evolution.…”

“…Against this backdrop, realizing that housing markets are regional in nature, with tremendous heterogeneity in terms of their response to (monetary) policy shocks [12][13][14], we analyze the role of various macroeconomic shocks in driving the Real Estate Investment Trusts (REITs) prices of the US, which tends to be homogenous across the country, being based on a broad single index. For our purpose, unlike Plakandaras et al [11], we use higher-frequency (monthly) data covering the more recent period 1972:12 of 2016:12. The use of monthly data allows us to identify the shocks in a relatively cleaner manner [15,16], based on a change-point vector autoregressive (VAR) model that allows for different regimes throughout the sample period and identifies a variety of shocks (supply, demand, monetary policy, and the spread between long-and short-run maturities), derived from the theoretical reactions of an innovative general equilibrium model developed by Liu et al [17].…”

“…This approach enables the VAR model to endogenously identify changes to the structure of the real estate market, as widely discussed in Simo-Kengne et al [18], as well as variations to the properties of exogenous shocks during the sample period. We prefer to use this approach over the complete TVP-VAR framework used by Plakandaras et al [11], as we want to explicitly identify regimes over our high-frequency data, rather than assuming that each point in time is a separate regime, as done in TVP-VARs-which is, perhaps, more appropriate at lower frequency data (like quarterly and annual). It is important to note that the spread shock is important for us, since the time period of our analysis involves the period of ZLB and hence, that of unconventional monetary policy, which in turn involved compression in the long-term yield spread (Beginning in the summer of 2007, money markets around the world experienced sustained periods of dysfunction with sharply higher short-term interest rates for commercial paper and interbank borrowing.…”

Monetary policy and bubbles in US REITs

“…The root of the global economic and financial crisis of 2008-2009 is commonly associated with the rapid decline in real estate prices, following a prolonged boom. Since there exists a large literature on the impact of monetary policy on general real estate prices and vice versa (see for example, Del Negro and Otrok (2007), Bjørnland and Jacobsen (2010), Bjørnland and Jacobsen (2013), Rahal (2016), Simo-Kengne, Miller, Gupta, and Balcilar (2016), Marfatia, Gupta, and Cakan (2017)), Huber and Punzi (2018), Plakandaras, Gupta, Katrakilidis, and Wohar (2018), it is not surprising that there is now a revived interest in the long standing debate on whether and how monetary policy should respond to perceived deviations of real prices from fundamentals. Given the beliefs that asset price bubbles are difficult to detect and measure, and that interest rates are a blunt instrument to prick a bubble resulting in unintended collateral damages, the consensus view is that central banks should focus on stabilizing inflation and the output gap only (Bernanke and Gertler (1999); Bernanke and Gertler (2001); Kohn (2006)).…”