Stable NGDP growth can stabilise the property market

It is often argued that falling and low interest rates sparked a global housing bubble. However, the empirical evidence of this is actually quite weak and the development in global property markets is undoubtedly much more complicated than often argued in the media – and by some economists.

Personally I have always been critical about the sharp rise in property prices we have seen in many countries, but trusting the markets I have also been critical about simplified explanations of that increase.

Now a new paper by Kenneth N. Kuttner provides more empirical evidence on the global property market trends. Here is the abstract of Kuttner’s paper “Low Interest Rates and Housing Bubbles: Still No Smoking Gun” (I stole the reference from Tyler Cowen):

“This paper revisits the relationship between interest rates and house prices. Surveying a number of recent studies and bringing to bear some new evidence on the question, this paper argues that in the data, the impact of interest rates on house prices appears to be quite modest. Specifically, the estimated effects are uniformly smaller than those implied by the conventional user cost theory of house prices, and they are too small to explain the previous decade’s real estate boom in the U.S. and elsewhere. However in some countries, there does appear to have been a link between the rapid expansion of the monetary base and growth in house prices and housing credit.”

Hence, we can not conclude that low interest rates generally created housing bubbles around the world.

Kuttner has for example an interesting point about the rise in US property prices and interest rates (UC = user costs/interest rates):

 “For one thing, the timing does not line up. House prices began to appreciate in 1998, three years before the drop in UC, and by 2001 the FMHPI index  (property prices) had already outpaced rents by 10%. The initial stages of the boom therefore appear to have had nothing to do with interest rates. It is only after 2001 that low interest rates enter the picture.”

Luckily for me Kuttner highlights two countries as having the most spectacular property market booms – Iceland and Estonia. I guess it should be known to my readers that I on my part (in my dayjob) warned about the boom-bust risks in both Iceland (in 2006) and in Estonia (in 2007). In these countries Kuttner demonstrates that there is a close relationship between overly easy monetary policy (strong money base growth) and the increase in property prices. These are, however, special cases and even though we saw a global trend towards higher real property prices in the prior to 2008 there are very significant differences from country to country.

Kuttner’s paper is very interesting and do certainly shed some light on the developments in the global property markets. However, I miss one thing and that is what impact the increased macroeconomic stability during the Great Moderation had on property prices. I have done some very simple and preliminary econometric studies of the impact of the (much) lower variance in NGDP growth during the Great Moderation on the US stock market. I have not done a similar study of the impact of the property markets, but I am sure that if Kuttner had included for example a 5-year rolling variance of NGDP growth in this estimates then he could have demonstrated that the increased stability of NGDP growth of the Great Moderation had a very significant impact on property prices. In fact I will argue that the increase in the stability of NGDP growth during the Great Moderation played at least as big a role in the increase in property prices as the drop in real interest rates. I challenge anybody to test this empirically.

If I am right then the best way for central banks to end the property market bust is to stabilise NGDP growth.


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  1. Alex Salter

     /  January 15, 2012

    Interest rates are a price; change relative prices and expenditure patterns change too. I’m skeptical that any empirical investigation can demonstrate a deviation from the counterfactual world where interest rates were not skewed by the monetary authority. In order for such an empirical study to be definitive, its authors would need to tell us what interest rates would be had there been no Fed (or a Fed which only acted through an NGDP target).

    You can argue the boom/bust was larger due to the moral hazard (implicit bailout guarantee) than it would have been otherwise. In fact, I’m sympathetic to the argument that without these guarantees, the boom/bust would have been much more mild. But that’s not the same thing at all as saying, “Interest rates weren’t that important,” because you still haven’t answered, “Well, compared to what?”

  2. Lars House prices in the US “took off” in 1998. That´s coincident with the Asian crisis and the current account adjustment required in those countries. You´ll notice that that´s when the US current account deficit increased significantly. Resources in Asia were being transferred from the non tradable sector to the tradable sector. The opposite happened in the US. That´s how Asia “exported” houses to the US. Take into consideration all the “homeownership policies” undertaken since the early 1990s and there you have the major reason for the strong increase in residential investment.

  3. Benjamin Cole

     /  January 15, 2012

    Nice blog–but remember, US commercial property markets cratered just as bad.

  4. David Eagle

     /  January 16, 2012

    You said to end the housing bust, we need to stabilize NGDP growth. I believe that is not enough as it sounds too much like NGDP growth rate targeting. To help the housing marking recover we need to recover some if not all the gap between where NGDP is now and what the prerecession’s trend for NGDP. This is an obvious comment from me given my support for NGDP targeting and my opposition to NGDP growth rate targeting.

  5. Benjamin Cole

     /  January 17, 2012

    Central banks not only need to grow NGDP, but also reflate property markets pronto.

    See Japan–the central bank there forever fretted about inflation, and property markets have been falling for 20 years. A brutal wipeout for property owners and lenders.

    For what? To obtain deflation? The goal of macroeconomic policy should be deflation, but not prosperity?

  6. David, yes you are right. My point is that the Fed need to announce a policy to ensure that NGDP is returned to its pre-crisis trend and then target a 5% (or so) growth path for NGDP. That surely would stabilise the US property market. That said, that would not be the main argument for NGDP targeting, but just a positive side-effect of the policy.

    Benjamin, I agree we need to have central banks target NGDP. Should the engage in a policy to relate property prices. Certainly not in my view. Central banks should concern themselves with targeting asset prices. That said, if the ECB and the Fed brought back NGDP to the pre-crisis trend then I don’t think we would be talking about a housing crisis anywhere.

  7. David Beckworth

     /  January 17, 2012


    This should be no surprise, but I found much to disagree with Kuttner’s paper and articulated why so here:


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