1 The Link between Output, Inflation, Monetary Policy and Housing Price Dynamics June 2009 Markus Demary, Research Center for Real Estate Economics,

Markus Demary, "Housing Price Dynamics", June The Link between House Prices and Key Macroeconomic Aggregates A large fraction of households‘ net worth is invested in housing A large fraction of households‘ net worth is invested in housing Housing has the important part of being collateral for mortgage financing Housing has the important part of being collateral for mortgage financing A large fraction of private liabilities are mortgage loans A large fraction of private liabilities are mortgage loans Changes in house prices change households‘ wealth and thereby households‘ consumption expenditures Changes in house prices change households‘ wealth and thereby households‘ consumption expenditures Changes in house prices change households‘ borrowing constraints Changes in house prices change households‘ borrowing constraints Monetary policy moves translate to mortgage market rate changes Monetary policy moves translate to mortgage market rate changes Housing demand may change during the business cycle Housing demand may change during the business cycle Housing might be a hedge against inflation Housing might be a hedge against inflation

Markus Demary, "Housing Price Dynamics", June How Do House Prices and Macroeconomic Aggregates Interact? Behavior at business cycle frequencies Behavior at business cycle frequencies  How large is the volatility of the house price cycle?  How persistent are house price cycles?  Do they lead or lag the business cycle? The interplay between house prices and macro variables The interplay between house prices and macro variables  How do GDP, inflation and interest rates move house prices?  How do house prices move GDP, inflation and interest rates?  What are the relevant transmission channels?

Markus Demary, "Housing Price Dynamics", June Data and Methodology Used Dataset Used Dataset  OECD dataset on real house prices, real GDP, GDP-deflator, money market rates  spannig the period 1970Q1 to 2005Q4, also used in several studies Methodology 1: Hodrick-Prescott-filtered cyclical components Methodology 1: Hodrick-Prescott-filtered cyclical components  Volatilities, Autocorrelations and Cross-Correlations Methodology 2: Vector-Autoregressions for the levels of the data series Methodology 2: Vector-Autoregressions for the levels of the data series  Expected future time development after shock  Contribution of shocks  Assumption 1: time lag of inflation response to GDP  Assumption 2: time lag in inflation and GDP response to interest rates  Assumption 3: monetary policy reacts to inflation and GDP without a lag  Assumption 4: house prices react without a lag

Markus Demary, "Housing Price Dynamics", June House Prices Have the Most Volatile Cycle Volatilities at Business Cycle Frequencies Price Level GDP Interest Rate House Prices Australia Australia0,0170,0130,0190,042 Denmark Denmark0,0110,0140,0160,057 Finland Finland0,0190,0210,0160,070 France France0,0100,0090,0150,155 Germany Germany0,0070,0180,0160,018 Japan Japan0,0170,0140,0160,044 Netherlands Netherlands0,0100,0130,0170,059 Spain Spain0,0140,0110,0190,053 UK UK0,0230,0150,0180,069 USA USA0,0090,0160,0170,021

Markus Demary, "Housing Price Dynamics", June House Prices Have the Most Persistent Cycle Autocorrelations at Business Cycle Frequencies Price Level GDP Interest Rate House Prices Australia Australia0,8270,7140,7360,884 Denmark Denmark0,8640,8050,8780,899 Finland Finland0,8670,9050,7170,952 France France0,9010,8530,8130,974 Germany Germany0,8000,6190,8780,925 Japan Japan0,9020,8050,8350,942 Netherlands Netherlands0,8180,5410,7440,945 Spain Spain0,8750,8250,5160,915 UK UK0,8960,8060,8010,941 USA USA0,9330,8700,7840,912

Markus Demary, "Housing Price Dynamics", June Business Cycle Comovements Correlations between House Prices and... GDP (-2 Quarter) GDP GDP (+2 Quarter) Australia Australia0,3810,4850,340 Denmark Denmark0,4470,6330,657 Finland Finland0,7190,7970,703 France France0,1120,0600,031 Germany Germany0,0380,3170,156 Japan Japan0,6740,6050,306 Netherlands Netherlands0,1870,3290,349 Spain Spain0,5100,5120,388 UK UK0,6600,6160,341 USA USA0,6480,6600,532

Markus Demary, "Housing Price Dynamics", June House Prices Move with GDP Impulse Responses to an Inflationary Shock... Price Level GDP House Prices Interest Rates Australia Australia+--+ Denmark Denmark+++- Finland Finland+--+ France France+--+ Germany Germany+--- Japan Japan+--- Netherlands Netherlands+--+ Spain Spain++++ UK UK+--+ USA USA+--+

Markus Demary, "Housing Price Dynamics", June Aggregate Demand Pushes House Prices Impulse Responses to an Output Shock... GDP Price Level House Prices Interest Rates Australia Australia+++- Denmark Denmark+++- Finland Finland++++ France France++-+ Germany Germany++++ Japan Japan++++ Netherlands Netherlands+++- Spain Spain+++- UK UK+++- USA USA++++

Markus Demary, "Housing Price Dynamics", June House Prices Decline When Policy Tightens Impulse Responses to an Interest Rate Shock... Interest Rates House Prices GDP Price Level Australia Australia+--+ Denmark Denmark+--- Finland Finland+--+ France France+--+ Germany Germany++-+ Japan Japan+--+ Netherlands Netherlands+--+ Spain Spain+--+ UK UK+--+ USA USA+--+

Markus Demary, "Housing Price Dynamics", June The House Price Shock Pushes Aggregate Demand Impulse Responses to a House Price Shock... House Prices GDP Price Level Interest Rates Australia Australia+-++ Denmark Denmark+++- Finland Finland++++ France France+0++ Germany Germany++++ Japan Japan++++ Netherlands Netherlands+0+- Spain Spain++++ UK UK+-++ USA USA+-++

Markus Demary, "Housing Price Dynamics", June Interest Rates Drive House Price Fluctuations Contribution of Shocks to... to House Price Fluctuations Price Level Output Interest Rate House Prices Australia Australia0,39%12,24%9,43%77,94% Denmark Denmark1,20%12,94%2,12%83,74% Finland Finland0,67%13,88%2,05%83,40% France France0,25%0,25%18,74%80,76% Germany Germany2,32%3,15%0,15%94,38% Japan Japan27,89%0,99%21,65%49,48% Netherlands Netherlands0,04%2,08%17,21%80,67% Spain Spain2,34%0,25%1,66%95,75% UK UK6,08%6,72%12,76%74,43% USA USA32,84%0,22%24,18%42,75%

Markus Demary, "Housing Price Dynamics", June House Prices Drive Interest Rate Fluctuations Contribution of House Price Fluctuations to... Price Level Output Interest Rate Australia Australia14,25%1,66%19,94% Denmark Denmark0,37%12,79%24,71% Finland Finland4,61%14,98%13,62% France France4,41%0,02%5,65% Germany Germany10,48%2,36%18,04% Japan Japan19,38%2,37%40,24% Netherlands Netherlands0,04%0,04%6,66% Spain Spain0,23%19,87%14,61% UK UK0,57%1,22%25,66% USA USA13,22%13,22%11,74%

Markus Demary, "Housing Price Dynamics", June Conclusion and Outlook Empirical assessment of the link between house price fluctuations and key macroeconomic aggregates Empirical assessment of the link between house price fluctuations and key macroeconomic aggregates Empirical evidence that GDP and interest rates are a key macro driver of house prices Empirical evidence that GDP and interest rates are a key macro driver of house prices Empirical evidence that house price changes translate to changes in aggregate demand Empirical evidence that house price changes translate to changes in aggregate demand House prices might be an indicator for future inflationary pressures and future recessions House prices might be an indicator for future inflationary pressures and future recessions Central banks might put weight on monitoring house prices Central banks might put weight on monitoring house prices

Markus Demary, "Housing Price Dynamics", June Thank You for Your Attention