Are House Prices Shaped By Monetary Policies? — A Review Of Empirical Evidences

In the realm of classical economics, the examination of the impact of monetary policy on housing markets did not garner significant attention until the 1970s, particularly after the occurrence of the 2008 financial crisis. This development can be attributed to the announcement made by the US President Richard Nixon on August 15, 1971, which signaled the end of the Bretton Woods system (note 1) of fixed exchange rates established at the end of World War II (US Office of the Historian, n.d.). It led to the adoption of a fiat money standard globally, thereby resulting in many countries transitioning to free-floating currencies and redefining the roles of central banks.

After the Nixon Shock, it empowers the Fed to increase unlimited money supply to support the US government or to save economic crises. Figure 1 reflects the sharp increase in the debt securities and loans of all sectors in the US after the Nixon Shock.

For example, in response to the global financial crisis since 2008, the US government implemented an unprecedented expansionary monetary policy that involved Quantitative Easing (QE1, QE2, and QE3) and historically low interest rates. Other countries have also adopted similar measures. In 2020, following the outbreak of the COVID-19 pandemic, the world resorted to a series of expansionary monetary policies to mitigate the impact of the recession. This article reviews studies on the effects of monetary policy on housing prices to summarize the impacts of global monetary policy on housing prices since 2008.

“After the global financial crisis that started in 2007, central banks in advanced economies eased monetary policy by reducing interest rates until short-term rates came close to zero, limiting options for additional cuts. Some central banks used unconventional monetary policies, buying long-term bonds to further lower long-term rates. Some even took short-term rates below zero. In response to the COVID-19 pandemic, central banks took actions to ease monetary policy, provide liquidity to markets, and maintain the flow of credit. To mitigate stress in currency and bond markets, many emerging market central banks used foreign exchange interventions, and for the first time, asset purchase programs. More recently, in response to rapidly growing inflation, central banks around the world have tightened monetary policy by increasing interest rates.” (IMF, 2023)

Taking the Federal Reserve of the US as an illustration, Figure 2 shows the substantial increase in the Fed’s assets from less than US$1 trillion before 2009 to more than US$4 trillion in 2015 and further increase to about US$8.4 trillion in Feb. 2023. The two phases of expansionary monetary policy have increased money supply by more than seven folds in the US.

Monetary policies have become highly coordinated among central banks of developed economies to weather global economic shocks. For example, “in 2020, after the outbreak of the pandemic, there were 207 interest rate cuts by central banks. Just in 2020 Q1, there were 73 interest rate cuts by 54 central banks to support the economies and some were even cut to historic lows. Some central banks also relaxed liquidity rules on banks, such as the removal of the loan-to-value ratio restrictions on new mortgages in New Zealand. The global financial markets were flooded with liquidity in this period. [Then] in the wake of a rapid deterioration in inflation, especially after the outbreak of the Russian–Ukraine war since February 2022, many central banks started increasing interest rates and turned the accommodative monetary policy into a contractionary one. In 2022 Q2, 55 central banks around the world turned around to raise interest rates 62 times, each time not less than 50 basis points. In the first three quarters of 2022, the world recorded a total of 8190 basis points in central bank interest rate hikes, and just counting the G10 countries alone, their central banks raised interest rates by a total of 1850 basis points.” (Yiu, 2023b)

Theoretically, accommodative monetary policies, such as the QE, create an incentive for investors to “search for yield” by looking for more profitable investments such as in the residential real estate sector (IMF, 2019), which is seen by investors as a safe and attractive bet, especially in big cities (Amaral, Dohmen, Kohl & Schularick (2021).

Thus, evidence of a strong positive impact of accommodative monetary policy on house prices has been extensively covered in the literature. There have been more and more empirical evidence pointing to the impacts of monetary policy on housing prices in the world since the Global Financial Crisis (GFC) in 2008, as shown in the following review.

Accommodative Monetary Policy since the GFC

The period from 2008 to 2022 is a special period that most central banks of developed countries have pursued accommodative monetary policy resulting in a long period of low or even negative short-term interest rates. The two sub-periods of QEs and interest rate cuts, one after 2008 and the other after 2020, provide testing samples for the impacts of monetary policy on housing markets. Malovaná, Bajzík, Ehrenbergerová & Janků (2022) reviewed more than 200 empirical literature on the impacts of low interest rates on asset prices and financial stability, and concluded that “a prolonged period of low interest rates may lead to a point of no return by contributing to higher indebtedness, overvalued asset prices and underpriced risks, resource and credit misallocation, and lower productivity.” For example, they reviewed Jordà, Schularick & Taylor (2015) which showed, by using a sample of 17 advanced economies from 1870 to 2012 and the international macroeconomics trilemma as an instrument for exogenous movements in interest rates, that more accommodative monetary policy leads to above average lending and an increase in housing prices. Yet, they have not covered recent studies in or after 2020, which is the stage two period of global accommodative monetary policy. This article further extends the review to some of the studies focusing on the monetary policy effects on housing markets after the outbreak of the COVID-19 pandemic.

Initial Evidence before 2008

Goodhart and Hoffman (2008) used a fixed-effects panel VAR model to analyze quarterly data from 1970 to 2006 for 17 industrialized countries. Their study examined the bi-directional relationship between lending and property prices, considering reversal causality bias. They reviewed numerous previous studies and found multidirectional links between house prices, broad money, private credit, and the macroeconomy. However, their results indicated that “the effects of shocks to money and credit on house prices are stronger when house prices are booming than otherwise, although not in a statistically significant way…” (p. 31)

In a similar vein, Calza, Monacelli, and Stracca (2009) estimated a baseline VAR model for 19 advanced countries using quarterly data from 1970:1 to 2008:2. They found that monetary effects on housing markets are more potent in countries where the underlying mortgage market is more developed and mortgages are primarily of the variable rate type (p.16). Their model identified three channels through which monetary policy transmits impacts onto financial markets, namely the nominal-debt effect, collateral-constraint effect, and asset-price effect (p.27).

Adam and Füss (2010) presented empirical results that “strongly confirm the theoretical implications of the DW model.” Their study used a panel cointegration analysis consisting of 15 OECD countries over a 30-year period (1975–2007) and confirmed, among other findings, the negative impact of long-term interest rates on house prices.

More Evidence from 2008 to 2019

Rahal (2016) used VAR models on eight OECD countries to find that an unconventional monetary policy shock in the form of an increase in central bank total assets has an effect not only on house prices but also on residential supply and mortgage markets.

Geng (2018) modeled long-run equilibrium house prices in 20 advanced economies in the OECD using a small set of supply and demand fundamental drivers of house prices. They found both demand-side and supply-side effects on house prices, including that a 1% rise in per capita disposable income raises average house prices by 1.5–1.7%, a 1% increase in the real mortgage rate reduces average real house prices by 1.8–2.8%, and a 1% increase in housing stock per capita is associated with a reduction in house prices by about 1.3% in countries with no rent control (pp. 15–16).

Nocera & Roma (2018) used a structural Bayesian stochastic search variable selection VAR model across euro area countries, the UK, and US to find that a 1% increase in the short-term interest rate reduces house prices by 6.4%.

Bunn, Pugh & Yeates (2018) used data from the ONS Wealth and Assets Survey on households’ characteristics and balance sheet positions to confirm that the accommodative monetary policy implemented after the 2008 Global Financial Crisis in the UK imposed short-term impacts on asset prices and wealth distributions from 2008 to 2014.

In contrast, Lenza & Slacalek (2018) found negligible effects of monetary policy on wealth inequality by studying the effects of quantitative easing on the income and wealth of individual euro area households.

Rosenberg (2019) used a Bayesian structural vector autoregressive model over a period of nearly 30 years to find that “expansionary shocks to the policy rate and the balance sheet both have a positive impact on house prices in the Scandinavian countries.”

Wilhelmsson (2020) used a structural vector autoregression (SVAR) model of the Swedish economy over the period 1993–2018 to find that “interest rates have both a direct effect on housing prices and an indirect impact through the bank lending channel.”

Shida (2021) used panel error correction models of a sample of 21 countries to find that a 1% increase in the long-term real interest rate decreases house prices by 7%. The results also showed that more liberalized mortgage markets lead to a greater impact of interest rate changes on house prices.

Hülsewig & Rottmann (2021) examined the effect of the European Central Bank’s (ECB) monetary policy on euro area house prices over the period 2010–2019 and found that “real house prices rise after an unexpected monetary policy loosening.”

Strong Evidence from 2019 to 2022

The period from 2019 to 2022 was characterized by the COVID-19 pandemic and the Russian-Ukraine war, creating a double-shocking period with a lethal disease and bloody battles. Initially, a global ultra-low interest rate regime was put in place to mitigate the negative impact of the pandemic, but this was followed by a rapid increase in interest rates to combat worsening inflation. Despite the significant impact of monetary policy on the housing market, there have been very few studies on the topic. However, there are some notable studies worth mentioning.

Di Casola et al. (2022) of the ECB conducted a study on the shocks in the Euro area from 2013 to 2021. They estimated the impact of country-specific Bayesian vector autoregression models and confirmed that, besides housing demand shocks, “monetary policy shocks combined with mortgage supply shocks contributed to the house price increases across advanced economies.” Figure 3 illustrates the negative association between real interest rates and real house prices in the Euro area. However, this study does not cover the recent interest rate hike since 2022.

Battistini, Gareis & Roma (2022) of the ECB also studied the impact of monetary policy on house prices in the Euro area from 2019Q4 to 2022Q1. In a linear model, they found that “a 1 percentage point increase in the mortgage rate leads, all else being equal, to a decline in house prices of around 5% after about two years” (Figure 4a).

Asset price theory suggests a non-linear relationship between mortgage rates and house prices, with lower mortgage rates leading to greater discounting effects on future rents and prices (Himmelberg, Mayer, & Sinai, 2005). This non-linearity is confirmed by Battistini et al. (2022), who found that “in a low-interest-rate environment, the estimated decline in house prices and housing investment in response to a 1 percentage point mortgage rate increase is about 9% and 15%, respectively, after about two years” (Figure 4b).

I have also conducted three recent publications (Yiu, 2021, 2023a, 2023b) studying the impact of monetary policy on housing prices during the pandemic and/or the Russian-Ukraine war periods. The first publication is a panel analysis of five countries during the accommodative monetary policy period of the pandemic, the second is on the housing market of New Zealand, and the third is an extension of the first study to a panel analysis of ten countries during both the accommodative monetary policy period of the pandemic and the contractionary monetary policy period of the Russian-Ukraine war. All three studies showed strong associations, with the New Zealand study establishing a link between monetary policy, mortgage loan amounts, and house prices. The recent two studies used the abrupt changes in monetary policy from 2020 to 2022 as natural quasi-experiments to demonstrate the causality channel from monetary policy to housing price changes.

In my study (Yiu, 2023a), I conducted a time series regression analysis on the New Zealand housing market from 2016 Q2 to 2022 Q3. The results confirmed that mortgage rates have a negative and significant effect on house price changes after controlling for economic growth and housing supply factors, regardless of whether the monetary policy was in an expansionary or contractionary mode. Robustness tests showed that a 1% fall/rise in mortgage rates caused a 5.6% increase/decrease in house prices, ceteris paribus. The magnitude of the effect is similar to the findings of the ECB study above. Figure 5 illustrates the associations between interest rates, mortgage loan amounts, and house prices.

In my another global study (Yiu, 2023b) using a ten-country panel regression analysis, the results confirmed that, after controlling for GDP growth and unemployment factors, changes in real interest rate impose a negative effect on house price growth rates. Figure 6 shows the negative associations between real interest rates and house prices yoy of the ten countries, viz. Australia (AUS), Canada (CAN), Germany (DEU), France (FRA), Great Britain (GBR), Italy (ITA), Japan (JPN), South Korea (KOR), New Zealand (NZL), USA (United States of America).

Notes:

1. After the World War II, the United States and the other advanced countries established “the Bretton Woods System, under which the U.S. pegged the dollar to gold at $35 per ounce and the other countries pegged to the dollar. The link to gold may have carried over some of the credibility of a nominal anchor and helped to keep inflation low.” (Bordo, 2007)

References

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