Housing Prices and the Macroeconomy: Evidence from a Panel of European Mediterranean Countries: A Note

By Apergis, Nicholas | Indian Journal of Economics and Business, June 2006 | Go to article overview

Housing Prices and the Macroeconomy: Evidence from a Panel of European Mediterranean Countries: A Note


Apergis, Nicholas, Indian Journal of Economics and Business


NICHOLAS APERGIS

Department of Financial and Banking Management

University of Piraeus, Piraeus 18534, Greece

Abstract

This study analyses the dynamic effects of specific macroeconomic variables on the price of new houses sold in a panel of European Mediterranean countries, i.e. Spain, France, Italy, Portugal, and Greece. A panel data approach is employed, while an error correction vector autoregressive (ECVAR) model is used in modelling the impact of the macroeconomic variables on real housing prices. Variance decompositions show that the housing loan rate is the variable with the highest explanatory power over the variation of real housing prices, followed by employment.

JEL Classification System: G24; E20; E40; E50

Keywords: Housing prices; macroeconomic factors; panel data; Mediterranean countries

I. INTRODUCTION

Over the past few years the world real estate industry is undergoing drastic reforms due to the liberalization of financial markets, the drastic fall of interest rates, the obsolesce of the existing stock of houses, and the change of consumer norms about housing uses. In addition, the housing sector has been a target of government fiscal and monetary policy aimed at achieving low inflation and unemployment and balanced growth.

Real estate cycles, i.e. periods of excess building, followed by contraction in construction, are primarily affected by shocks in the form of fiscal and monetary policy. For example, a sudden increase in the money supply reduces interest rates, and if everything else being equal, the user cost of housing services falls, while quantity demanded of housing services gets higher. The quantity demanded and the real price of housing units increase as well, since housing services are linked one to one to housing units (Baffoe-Bonnie, 1998).

In addition to money supply, other economic variables, such as employment and mortgage interest rates, can affect both housing prices and construction of new houses. Building activity is stimulated by higher employment growth (Smith and Tesarek, 1991; Sternlieb and Hughes, 1997). The mortgage interest rate is a very important variable influencing the decision of individuals to buy a house. When the mortgage rate increases, people are prevented from buying houses; therefore, the demand for housing decreases. It has been argued that significant interest-rate effects on consumer expenditure are expected through housing wealth, especially in systems characterized by the importance of the collateral role of houses (Muellbauer, 1992; Muellbauer and Murphy, 1997; Maclennan et al., 1998). Earlier studies, which analysed the effect of macroeconomic aggregates on the housing sector (i.e. Kearl, 1979; Follain, 1981; Schwab, 1983; Manchester, 1987; and Harris, 1989), have not allowed for the fact that these macroeconomic variables are themselves influenced by demand and supply shocks on the housing sector. Among recent relevant studies, Baffoe-Bonnie (1998) has developed a vector autoregressive (VAR) model, which takes into account the full interaction of the housing sector with the rest of the economy.

The goal of this paper is to empirically investigate the effects of specific macroeconomic variables on real housing prices of new houses sold in a panel of European Mediterranean countries, namely Spain, France, Italy, Portugal and Greece. To the best of the authors' knowledge, there is not any relevant panel data study on housing prices. Moreover, these countries were on purpose selected on the grounds that they experienced the smallest real changes in real housing prices over the period under study (Stephens, 1995, Table 1). All of these countries experienced large increases in nominal house prices. However, these increases were virtually vanished when the inflation rate was taken into consideration. The housing sector is an important sector for all five economies under study. …

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