House Price Dynamics with Household Debt: The Korean Case*

• Author: Jong Chil Son,Hyun Jeong Kim,Myung‐Soo Yie
• Published date: 01 March 2017
• Date: 01 March 2017
• DOI: http://doi.org/10.1111/asej.12112

House Price Dynamics with Household Debt: The

Korean Case

*

Hyun Jeong Kim, Jong Chil Son and Myung-Soo Yie

Received 25 February 2013; accepted 23 November 2016

This paper revisits the long-run determinants of house prices, and analyzes the

house price dynamics using Korean data taking into account the close relationship

between house prices and household debt. The results of cointegrating regression

indicate that the major portion of the rise in house prices in Korea over the last

15 years can be explained by changes in macrovariables such as household income,

the demographic structure, the user cost of home ownership and the housing stock

supply. The results also confirm that house prices are, indeed,closely linked to the

steep increase in household debt seen over this period. Estimation of an error cor-

rection model shows that the extent of convergence of actual house prices to their

long-run equilibrium path has weakened somewhat since the global financial crisis

while the speed of convergence has slowed, indicating structural changes in the

Korean housing market. Finally, a forecast for house prices over the next several

years suggests that they are unlikely to rise as sharply as they did in the 2000s, given

the likely changes in the macro-financial environment, and that their future path will

be closely associated with that of the household debt-to-income ratio.

Keywords: cointegrating regression, error correcting process, forecast, house

prices, household debt.

JEL classification codes: E44, C32, J10.

doi: 10.1111/asej.12112

I. Introduction

The literature analyzing the determinants of house prices and the interactions be-

tween house prices and household debt in major economies has been growing

(e.g. Gerlach and Peng, 2005; Antipa and Lecat, 2009; Gimeno and Martinez-

Carrascal, 2010; Mian and Sufi, 2009, 2014), especially since the 2008 global

financial crisis. Similar research on emerging market economies (EME), including

Korea, is limited, however; very little is known about the links between house

prices and household debt in these economies, or about the long-run and

* Kim: Office of Branch Affairs, Bank of Korea, 39 Namdaemun-ro, Jung-gu, Seoul 04531, Korea.

Son (corresponding author): Division of Economics, Hankuk University of ForeignStudies, 107 Imun-

ro, Dongdaemun-gu, Seoul 02450, Korea. Email: jcson@hufs.ac.kr. Yie: Division of Economics and

Trade, Kongju National University, 56 Gongjudaehak-ro, Gonju-si, Chuncheongnam-do 32588, Korea.

This work was supported by HankukUniversity of Foreign Studies Research Fund of 2016. The views

expressed in this paper are those of the authors and do not necessarily reflect the views and policies of

the Bank of Korea.

© 2017 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2017, Vol.31 No. 1, 39–59 39

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short-run dynamics of their houseprices. In this paper we attemptto fill these gaps in

the literatureby exploring the issues raisedwith a special focus on Korea, whichhas

experienced concurrent increases in house prices and household debt for over a

decade. Specifically, we investigate the dynamics of house prices in Korea,

incorporating their long-run relations hip with household debt, using stock-flow and

error correction models, and then attempt to forecast house prices for the near future.

Our main findings regarding the factors affecting house prices in the long run,

and house price dynamics in the short r un, are consistent overall with those found

in the existing literature. Using the estimation results of the long-run equation, we

can explore how far actual house prices deviate from their long-run trend or equi-

librium path, especially during periods of house price booms. We find that the ex-

tents of difference between actual house prices and their long-run values could

differ greatly depending upon whether we take into account a measure of financial

deepening, for which we choose the household debt-to-income ratio. Indeed, if

household debt is included in the set of major variables affecting the long-run

house price trend, the gap is found to narrow substantially. Estimation of an error

correction model indicates that there has been a change in the dynamics of house

prices in Korea since the financial crisis, as the power and speed of convergence of

actual house prices toward their long-run trend have weakened and slowed since

then. When the full sample is used it is estimated to take more than 30 months

for the difference between actual and long-run house prices to narrow by half;

while using the pre-crisis sample alone it takes just 21 months. Finally, we con-

duct forecasting of house prices over the next several years based upon three sce-

narios regarding the household-debt-to income ratio, in which that ratio is

assumed to keep rising, remain at its cur rent level or gradually decline. The fore-

casts indicate that even under the upside scenario, long-run nominal house prices

are unlikely to rise rapidly again as in the 2000s, and that their future path will be

closely associated with that of the household-debt-to income ratio.

The remainder of this paper proceeds as follows. Section II summarizes previ-

ous studies on the determinants of house price dynamics in both the long and the

short runs, and on the relationship between household debt and house prices.

Section III explains the data and presents our main empirical findings. Section

IV concludes with some policy implications.

II. Literature Survey

Debelle (2004) and Dynan and Kohn (2007) point out that household mortgage

loans have grown greatly in major developed countries over the past two decades,

owing mainly to changes in tax codes

1

or demographic structures, to financial

1 According to Debelle (2004), mortgage lending has expanded in the USA since the 1986 tax re-

form that repealed all tax deductions on loan interest except that on mortgage loans. Similar tax ben-

efits for mortgage loans have also contributed to rises in household indebtedness and house prices in

the UK, the Netherlands, Finland, Norway and Sweden.

ASIAN ECONOMIC JOURNAL 40

© 2017 East Asian Economic Association and John Wiley & Sons Australia, Ltd