A comparison of two housing markets

Abstract

China is experiencing rapid increases in house prices similar in magnitude to that observed in the US housing market bubble. We use a simple vector autoregression model (VAR) to compare housing market dynamics in these two countries. We find that the US housing market responds very strongly to interest rate shocks and very little to money supply shocks. In contrast, the Chinese housing market responds strongly to both interest rate and money supply shocks. An inflation shock produces a larger response of house prices in China than in the US, and changes in house prices have a much stronger wealth effect in China than in the US. A major decline of house prices in China is likely to have a much bigger impact on the Chinese economy. Monetary policy in China needs to reply on both interest rate and quantitative measures to curb unsustainable increases in house prices.

Keywords:

• housing market
• monetary policy
• VAR
• wealth effect

JEL Classification:

• E44
• E52
• R31

Acknowledgement

Part of the paper was completed while the second author was visiting Jinan University. Shu Wu is thankful for their hospitality.

Funding

Zhengxun Tan greatfully acknowledges financial supports from Chinese National Science Foundation [grant number 12BJY161], Chinese Ministry of Education and Jinan University.

Notes

¹ Most other monetary VAR models use real GDP instead of real consumption. We use real consumption because we are particularly interested in measuring the wealth effect of house price increases.

² China does not have reliable quarterly consumption data until recent years, and major housing market reforms started in the 1990s.

³ We obtained almost the same result if we switch the order of interest rate and money growth in the VAR model.

⁴ Of course, this component does not need to be a nonrational house price bubble. For example, time-varying housing market risk premiums due to changes in investor’s preferences can also produce ‘exogenous’ changes in house prices even though the macroeconomic fundamentals remain the same.

⁵ Since we use a recursive identification scheme in our VAR, this variance decomposition actually gives a conservative estimate of the wealth effect of house prices on consumption.