DP10305 Betting the House

Author(s): Ņscar Jordą, Moritz Schularick, Alan M. Taylor
Publication Date: December 2014
Keyword(s): credit, financial crises, house prices, instrumental variables, leverage, local projections, monetary policy
JEL(s): C14, C38, E32, E37, E42, E44, E51, E52, F41, G01, G21, N10, N20
Programme Areas: International Macroeconomics, Economic History
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10305

Is there a link between loose monetary conditions, credit growth, house price booms, and financial instability? This paper analyzes the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. We exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. We use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.