Charles Goodhart

Boris Hofmann

Professor of Banking and Finance Charles Goodhart

House price bubbles, and their aftermath, have become a focus of macro-economic policy concern in most developed countries. This book elucidates the two-way relationship between house-price fluctuations and economic fundamentals. Housing has many features which make it distinct from other assets, like equity. Real estate is not only an asset but also a durable consumption good for households, providing shelter and other housing services. As a result, a house is often the largest and most important asset of households and therefore accounts for a major share of household wealth. Similarly a large share of bank assets is tied to housing values. House price fluctuations may, therefore, have a major effect on economic activity and the soundness of the financial system. Following an introductory chapter, the book is structured into three parts. The first demonstrates the importance of house prices as determinants or indicators of inflation and economic activity. The second focuses on the inter-relationships between bank credit extension and housing prices, and how bubbles can lead to financial crises. The third discusses resultant public policy issues, such as whether, and how, to include housing prices in a general inflation index, and how to restrain the housing/bank credit cycle.

Implications for Banking and Price Stability

House Prices and the Macroeconomy

Episodes of boom and bust in credit markets have often coincided with cycles in economic activity and property markets. The coincidence of these cycles has already been widely documented in the literature, but few studies address the issue in a formal way. In this study we analyse the determinants of credit to the private non-bank sector in 16 industrialised countries since 1980 based on a cointegrating VAR. Cointegration tests suggest that the long-run development of credit cannot be explained by standard credit demand factors. But once real property prices, measured as a weighted average of real residential and real commercial property prices, are added to the system, we are able to identify long-run relationships linking real credit positively to real GDP and real property prices and negatively to the real interest rate. These long-run relationships may be interpreted as long-run extended credit demand relationships, but we may also capture effects on credit supply. Impulse response analysis based on a standard Cholesky decomposition reveals that there is significant two-way dynamic interaction between bank credit and property prices. We also find that innovations to the short-term real interest rate have a strong and significant negative effect on bank credit, GDP and property prices.

Boris Hofmann

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