It seems that wherever you go these days you hear people talking about the housing market. This is perfectly understandable given that housing market developments can have a major impact on economic activity. The big gains in house prices in many countries have raised concerns about what might happen if these gains are reversed. Moreover, recent developments in the US housing market, in particular, and fairly widely shared fears on the adverse effects on the US economy and, more generally, the global economy may have helped to sustain this discussion.
In the United States, the debate over the problems in the housing market has resulted in a popular view that the housing sector is the root cause of three distinct but related problems. The first of these is the sharp decline in house prices and the related fall in home building. In addition, developments in the housing market can have adverse effects on the credit market, as witnessed by the subprime mortgage problem, which has triggered a substantial widening of all credit spreads and the freezing of much of the credit market. Finally, the current problems in the housing sector also underlie the decline in home equity loans and mortgage refinancing, which could in turn cause greater declines in consumer spending.
It could plausibly be argued that each of the above factors could alone be powerful enough to cause an economic downturn. Its central role in the economy means the housing market is of crucial concern to policymakers in many countries. Given the goal of price stability, and possibly also of promoting stable and sustainable real growth, monetary policymakers need to understand the role that housing markets play in the transmission of monetary policy if they are to optimize their policy choices. In this context, housing market research suggests we cannot overemphasize the importance of potential borrowing constraints facing households making decisions over housing market transactions. Naturally, the existence of such borrowing constraints depends critically on the depth of the housing finance systems, which, according to new empirical evidence, depends in turn on the strength of the legal rights of borrowers and lenders, the depth of the credit information system and the stability of the macroeconomic environment.
On the other hand, the effects of housing wealth on household consumption must depend on the dynamics of house prices. In this context, recent research suggests, interestingly, that the way borrowing constraints shape house price dynamics hinges upon whether house price changes are driven by shocks to aggregate income or to interest rates. Moreover, borrowing constraints mean that house price dynamics display important asymmetries between large positive and negative income shocks. This is because the share of borrowing-constrained households changes across income shocks of different size and sign.
The results outlined above are extremely important and interesting and should encourage economists as well as policymakers to put further effort into enhancing our understanding of the dynamic behaviour of housing markets. |