Academic journal article Journal of Economic Cooperation & Development

Returns Predictability in Emerging Housing Markets

Academic journal article Journal of Economic Cooperation & Development

Returns Predictability in Emerging Housing Markets

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

Just like any other security, real estate investment also has its risks including falling property values, lack of liquidity, limited diversification and sensitivity to certain economic and financial factors. The question we are looking for is if there is evidence of a significant link among house price indices, money, credit and the macro economy. Goodhart (2007) argue that modern-style macro models are inherently non-monetary. He claims "Since there are by construction no banks, no borrowing constraints and no risks of default, the risk free short-term interest rate serves to model the monetary side of the economy. As a consequence, money or credit aggregates and asset prices play no role in standard versions of these models."

Interest rates have direct effects on house prices. House prices appear to be associated with business-cycle movements in a number of real variables, such as consumption and investment. Researchers have not fully agreed on as to whether accommodative policy has contributed to the volatility of house or other asset prices. It can be argued that because house prices, macroeconomic and monetary variables move in response to other outside shocks hitting the economy, the direction of the relationship or the extent of causality among these variables can be difficult to point out.

The main objectives of the central banks are not necessarily in line with the goals for asset prices, particularly house prices; however house price changes can have important implications for economic activity and inflation. This effect has become especially more important since 2008 crisis. The consequences of excess changes in house prices also should be watched carefully by central banks and other government agencies that regulate financial institutions for the purpose of financial stability. Even though in the past, major declines in real house prices have often been associated with economic downturns, 2008 crises showed us that the opposite is also true; economic downturn can be caused by a decline in real house prices, especially when collateral values also decline significantly.

There is not a consensus among central banks as to how to react to excess changes in house prices. Some researchers argue that we should trust the markets therefore central banks should continue focusing on their goal of low inflation and output stability. However, there are also several researchers who claim central banks should act to prevent bubbles in house prices to avoid financial as well as macroeconomic turbulences. The question is then how should central banks respond to movements in asset prices? There is also not a consensus on this question. Some researches advise that the price index targeted by a central bank should also include the future prices of goods and services as well as assets. Some researchers, on the other hand, argue that as long as the asset prices affect the forecast of future goods and services price inflation, they can be subject to the monetary policy. They claim central banks should respond to changes in asset prices by calculating the effect of the change in asset prices on expected inflation, and then adjusting the interest rates. Several researchers also point out that the changes in asset prices have implications for the stability of the financial sector; therefore there is an indirect relationship with monetary policy as well. If there is a bubble in asset prices, a correction might be inevitable. When the correction occurs it can be very costly to financial institutions therefore can impair the financial stability. It is clear that understanding the sources of asset price movements becomes a key element in determining the necessary monetary policy response. Hence, movements of house prices and the how these movements effect the financial sector and the macro-economy should closely be monitored by monetary authorities and financial regulators. …

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