Determinants of housing bubbles' duration in OECD countries

• Author: Juan S. Amador‐Torres,Jose E. Gomez‐Gonzalez,Sebastian Sanin‐Restrepo
• DOI: http://doi.org/10.1111/infi.12128
• Date: 01 June 2018
• Published date: 01 June 2018

DOI: 10.1111/infi.12128

ORIGINAL ARTICLE

Determinants of housing bubbles' duration in

OECD countries

Juan S. Amador-Torres

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Jose E. Gomez-Gonzalez

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Sebastian Sanin-Restrepo

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1

Department of Inflation and

Macroeconomic Programming, Banco de

la Republica, Bogota, D.C., Colombia

2

Research Department, Banco de la

Republica, Bogota, D.C., Colombia

3

Financial Sector, Banco de la Republica,

Bogota, D.C., Colombia

Correspondence

Jose E. Gomez-Gonzalez, Research

Department, Banco de la Republica,

Carrera 7 No. 14-78, Bogota, D.C.,

Colombia.

Email: jgomezgo@banrep.gov.co;

je.gomez267@uniandes.edu.co

Abstract

We study the determinants of housing price bubbles'

duration for a set of OECD countries between 1970 and

2015. Our topic of study is of major importance, as duration

is a proxy for other dimensions, such as the magnitude of

bubbles, the extent of macroeconomic imbalances, and the

chance that a rational bubble turns into an irrational one. We

answer two related questions: (i) Does prolonged domestic

monetary-policy easing increase the duration of housing

price bubbles? (ii) Does prolonged monetary-policy easing

in the United States influence the housing bubbles' duration

in other OECD countries? We show that the answer to the

first question is a clear yes but that the answer to the second

question is not as clear. Our main result is that monetary-

policy tightening can accelerate the termination of a housing

bubble. In this sense, our findings provide support for

‘leaning against the wind’policies.

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INTRODUCTION

The recent international financial crisis has reawakened the debate over the scope of central banking

functions. One of the most heated disputes considers whether central banks should focus on the

traditional narrow goal of price stability or whether they should also worry about macroeconomic and

financial stability.

The traditional view promotes a separation of monetary and financial policies, arguing that interest

rate management is too blunt to achieve financial stability effectively. Hence, according to this view,

the goal of financial stability should be pursued only through effective microprudential policies.

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/infi International Finance. 2018;21:140–157.

However, even if this is true, ignoring the behaviour of interest rates and credit growth may lead to

policies that create distortions in asset prices.

Recent papers challenging this traditional view have raised questions regarding the interaction

between price stability and financial stability and the trade-offs between those goals, giving a new

role for central banking (see, for instance, Brunnermeier & Oehmke, 2013; Committee on

International Economic Policy and Reform, 2011). This surging strand of the literature has gained

relevance since the world has experienced a period of unprecedented monetary policy easing after

2007. Initially, this policy path dealt with only traditional interest rate instruments, but it later

stretched to considerable expansions of central bank balance sheets through the purchase of bonds

and other private assets. Although these actions were probably effective in preventing a

worldwide stagnation, they gave way to fears over a possible build-up of global macroeconomic

imbalances.

Various papers have studied the effects of unconventional monetary policy on both real and

financial sectors (see, for instance, Eggertsson, 2011; Hammoudeh, Nguyen, & Sousa, 2015).

Similarly, there is significant evidence that quantitative easing policies have affected long-term interest

rates in developed economies (see, for instance, Gagnon, Raskin, Remache, & Sack, 2010;

Krishnamurthy & Vissing-Jorgensen, 2011; Swanson, 2010), and the behaviour of capital inflows,

asset prices and long-term interest rates in emerging economies (e.g. Cho & Rhee, 2013; Fic, 2013;

Lim, Mohapatra, & Stocker, 2014).

Thus, studying the interaction between monetary policy and the behaviour of housing prices is highly

relevant. The literature on the optimal response of centralbanks to the occurrence of bubbles is ample, and the

debate in this regard is on-going (Bernanke & Gertler, 2001; Gambacorta & Signoretti, 2014; Mishkin, 2009,

among many others). Less attention has been given to the role of monetary policy easing on the formation of

asset price bubbles. Taylor (2011, 2012) argues that excessively low policy rates led to the housing bubble.

Rötheli (2010) maintains that monetary policy easing provoked the financial crisis through its effect on

housing (and other assets) prices. Papers in the tradition of the risk-taking channel

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show that prolonged

periods of expansionary monetary policy favour bank risk-taking. In a recent study, Cecchetti, Mancini

Griffoli, and Narita (2017) extend these findings by showing that non-financial firms also undertake higher

risks when the monetary policy eases. A few recent papers have argued that thelarge influx of liquidity created

by the quantitative-easing measures adopted by the world's major central banks is among the main causes of

the formation of housing bubbles in different countries (see, for instance, Blot, Hubert, & Labondance, 2017;

Brunnermeier & Schnabel, 2016).

Papers studying housing bubble formation have shown that there is vast heterogeneity in their

duration (Gomez-Gonzalez, Gamboa-Arbeláez, Hirs-Garzón, & Pinchao-Rosero, 2017; Pavlidis et al.,

2016). Importantly, they show that bubbles occurring around the recent international financial crisis

lasted significantly longer than did those that originated in the 1980s and 1990s. Studying what makes

some bubbles last longer than others is of great importance and has considerable policy implications,

especially if monetary policy plays a significant role in the duration of bubbles.

In this paper, we use hazard models to study the determinants of the duration of housing price

bubbles. Our main emphasis is on answering two related questions: First, does prolonged monetary

policy easing increase the duration of housing price bubbles? Second, does prolonged monetary policy

easing in the U.S. influence the duration of housing bubbles in other OECD countries? We show that

the answer to the first question is yes. The answer to the second question, however, is not clear-cut. We

find there is no significant direct effect of the monetary policy stance in the United States on the

duration of bubbles in other countries. However, there might be indirect effects, as in a financially

globalized environment, there tends to be certain degree of monetary policy synchronization among

countries (see, e.g. Arouri, Jawadi, & Nguyen, 2013).

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