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VoxEU Column Monetary Policy
HOW HOUSE PRICES RESPOND TO MONETARY TIGHTENING: THE ROLE OF CYCLICAL CONDITIONS
* Matthias Burgert
* Johannes Eugster
* Victoria Otten
* /
13 Mar 2024
How reactive are house prices to monetary policy shocks? Does their reaction
depend on cyclical conditions? And what do historical patterns suggest would be
a plausible house price reaction to the latest monetary tightening cycle? This
column tries to answer these questions by relying on the experience of 29 OECD
countries over the last four decades. The results point to a larger and more
protracted house price reaction than the literature has suggested, and to an
important role of initial cyclical conditions, which could – should the increase
in interest rates persist – significantly increase the medium-term effects of
the latest tightening cycle.
AUTHORS
MATTHIAS BURGERT
JOHANNES EUGSTER
VICTORIA OTTEN
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Real house price growth in OECD countries further accelerated after the onset of
the Covid-19 pandemic, from an already steep upward trend that began in the
early 2010s (Figure 1). Yet, soon after, housing markets were confronted with
the fastest monetary tightening in decades. A casual glance at the data, as well
as an abundant theoretical literature, would suggest that a cooling – or even a
substantial contraction – is on the cards. The conceptual argument often
involves non-arbitrage conditions: first, between renting and owning (Poterba
1984, Henderson and Ioannides 1983); and second, between investing in housing
rather than in other assets (Case and Shiller 1989, 1990). Yet, these
non-arbitrage conditions have been shown to be substantially weaker in reality
than in theory (Glaeser and Gyourko 2009, Duca et al. 2021), leaving the link
between interest rates and house prices a predominantly empirical question.
Figure 1 House prices and short-term interest rates (lhs: 2015=100, rhs: in %)
NOTE: UNWEIGHTED AVERAGES OF REAL HOUSE PRICE INDICES AND THE MONEY MARKET OR
TREASURY BILL RATES, RESPECTIVELY, OVER 29 OECD COUNTRIES. 1980Q1 – 2022Q4.
SOURCES: OECD.
In a recent paper (Burgert et al. 2024), we provide new evidence on how house
prices react to monetary policy rates and how this reaction depends on the
underlying cyclical conditions in the housing market and the broader economy.
For this, we rely on the experience of 29 OECD countries over four decades.
Relative to focusing on the experience of an individual country, this allows us
to exploit a far larger number of monetary and housing cycles as well as a more
diverse set of initial conditions.
We identify exogenous variations in domestic policy rates based on monetary
policy spillovers from the US, in the spirit of Jordà et al. (2015). 1 The
instrumentation strategy relies on the idea that – conditional on an accurate
description of domestic conditions – a tightening of monetary conditions in the
financial centre increases the likelihood of a domestic policy hike, in line
with the international ‘policy dilemma’ proposed by Rey (2015). We further allow
the effect of interest rates to differ across a range of economic indicators,
relying on the smooth transition functions (STFs) popularised by Auerbach and
Gorodnichenko (2012).
KEY RESULTS
Our key findings are the following. First, we find that following an exogenous
one percentage point increase in short-term interest rates, house prices
typically fall by up to 8% over a five-year period (Figure 2, left). This effect
materialises through a substantial transmission to typical mortgage rates
(Figure 2, centre) and a persistent decline in private credit (Figure 2, right).
Compared to the existing literature, which – according to a meta-study by
Ehrenbergerova et al. (2023) – suggests an average peak house-price reaction of
1.2% after just two years, our response is substantially larger and more
protracted. In the paper, we show that this difference is predominantly due to
our identification of monetary policy shocks, and the fact that the endogenous
component of an interest rate hike, such as an overheating economy, risks
attenuating the identified effect.
Figure 2 Monetary policy’s effect on house prices and its transmission
NOTE: THE FIGURE SHOWS THE IRFS OF REAL HOUSE PRICES (IN %), TYPICAL MORTGAGE
RATES (IN PP), AND HOUSEHOLD CREDIT (IN % OF GDP) TO A ONE PERCENTAGE POINT
INCREASE IN SHORT-TERM INTEREST RATES. THE SHADED AREA CORRESPONDS TO THE 90%
CONFIDENCE INTERVAL. ROBUST STANDARD ERRORS CLUSTERED AT THE COUNTRY LEVEL.
Second, we find that the effect on house prices varies substantially with
initial conditions. For example, the response of house prices is substantially
larger when interest rates are initially low (Figure 3A), and they materialise
faster when their rise occurs in a recession (Figure 3B) or when credit
conditions are already tight (Figure 3C). A preceding house price boom slows
price reactions at the outset but amplifies them in the medium-term (Figure
3D).
Figure 3 House price reaction depending on cyclical conditions
NOTE: THE FIGURE SHOWS THE IRFS OF HOUSE PRICES TO A ONE PERCENTAGE POINT
INCREASE IN SHORT-TERM INTEREST RATES DEPENDING ON THE UNDERLYING CONDITIONS,
CAPTURED BY THE LEVEL OF THE SMOOTH TRANSITION FUNCTION, CONSTRUCTED WITH A
TRAILING SEVEN-QUARTER MOVING AVERAGE OF GLOBALLY STANDARDISED VARIABLES. THE
RED CURVE (LOW STATE) CORRESPONDS TO THE STF TAKING A VALUE OF 0.8. THE BLUE
CURVE (HIGH STATE) CORRESPONDS TO STF=0.2. THE SHADED AREA CORRESPONDS TO THE
90% CONFIDENCE INTERVAL.
IMPLICATIONS FOR THE ONGOING TIGHTENING CYCLE
Finally, we illustrate the possible implications of our results by conditioning
the house price reaction on the economic context at the onset of the latest
monetary tightening cycle (i.e. in 2022Q1). For the average economy, these were
characterised by extraordinarily low short-term interest rates, a broadly
neutral credit cycle, a slightly positive real cyclical position (in terms of
GDP growth), 2 and unusually dynamic house price growth (Figure 4). Estimating
jointly the influence of these factors, we find that historically they
contributed to attenuating the house price reaction in the short-term but
amplified its impact in the medium-term (Figure 5).
Figure 4 The cyclical conditions in 2022-Q1
NOTE: THE FIGURE SHOWS THE MEDIAN AND THE INTERQUARTILE RANGE OF THE 2022-Q1 AND
THE AVERAGE VALUES OF THE STANDARDISED SEVEN-QUARTER MA OF THE OUTPUT GAP, THE
GROWTH OF HOUSEHOLD CREDIT (IN % OF GDP), THE LEVEL OF THE SHORT-TERM INTEREST
RATE AND THE GROWTH IN REAL HOUSE PRICES.
Figure 5 The semi-elasticities of house prices in 2022-Q1
NOTE: THE FIGURE SHOWS THE AVERAGE MODEL-IMPLIED SEMI-ELASTICITY OF HOUSE PRICES
TO A ONE PERCENTAGE POINT INCREASE IN SHORT-TERM INTEREST RATES GIVEN THE
CYCLICAL CONDITIONS OF 2022-Q1, CAPTURED BY THE LEVEL OF THE SMOOTH TRANSITION
FUNCTION OF GDP GROWTH (GDP), CREDIT GROWTH (CREDIT), THE LEVEL OF THE
SHORT-TERM INTEREST RATE (STIR), AND THE PAST HOUSE PRICE GROWTH (HP). THE
SHADED AREA CORRESPONDS TO THE 90% CONFIDENCE INTERVAL.
The estimated house price semi-elasticity, given the conditions in 2022-Q1, is
above 25. This is an order of magnitude bigger than the average effect from the
existing literature. Yet, two comments are in order. First, our coefficients
show the effect of an exogenous one percentage point shock to the policy rate.
Clearly, much of the observed change does not satisfy such a criterion and was
considered endogenous, both by market participants and by our model. Second, the
estimation coefficient shows the effect, conditional on the rich dynamics in our
model. The identified effect should thus be interpreted as a deviation from the
counterfactual path of house prices and not as a deviation from the level of
house prices at time t.
These caveats notwithstanding, historical patterns still suggest that the
medium-term outlook deteriorated substantially with the most recent tightening.
We illustrate this with the predicted 20-quarter forward growth rate. Over the
in-sample period, the predicted and actual growth rates follow each other very
closely (Figure 6a). The out-of-sample prediction, which is shown in Figure 6b
(and starts in 2018 due to the forward-looking horizon), is first broadly stable
but deteriorates significantly during the course of 2022. Under the strong
assumption that no further interest rate innovations will take place going
forward – implying a very sluggish normalisation of monetary policy – our model
would predict a real house price contraction between 12% and 28% (i.e. the
interquartile range) over the period ending in 2027.
NOTE: THE FIGURES COMPARE THE ACTUAL 20-QUARTER FORWARD GROWTH RATE (CHANGE IN
THE LOG) OF REAL HOUSE PRICES (IN BLUE) WITH THE PREDICTED CHANGE BASED ON OUR
MODEL OVER THE SAME HORIZON. THE SHADED AREA CORRESPONDS TO THE INTERQUARTILE
RANGE.
The objective of this column is not to make predictions about where house prices
are heading. After all, the pandemic-related shifts in housing-related
preferences, strong household balance sheets, and more pronounced supply
constraints may provide more persistent upward pressure on house prices than our
model can capture. However, the analysis does emphasise that house price
reactions to monetary tightening in the past have often been sluggish but large,
particularly when initial cyclical conditions resembled those of 2022. In
addition, our paper echoes the conclusion from a growing literature emphasising
the state contingency of monetary policy transmission (e.g. Tenreyro and
Thwaites 2016, Barnichon and Matthes 2018, Debortoli et al. 2020).
REFERENCES
Auerbach, A J and Y Gorodnichenko (2012), “Measuring the Output Responses to
Fiscal Policy”, American Economic Journal: Economic Policy 4(2): 1–27.
Barnichon, R and C Matthes (2018), “Functional Approximation of Impulse
Responses”, Journal of Monetary Economics 99(C): 41–55.
Burgert, M, J Eugster and V Otten (2023), “Interest rate sensitivity of house
prices: International evidence on its state dependence”, Working Paper, Swiss
National Bank, forthcoming.
Case, K and R Shiller (1989), “The Efficiency of the Market for Single-Family
Homes”, American Economic Review 79(1): 125–37.
Case, K and R Shiller (1990), “Forecasting Prices and Excess Returns in the
Housing Market”, Journal of Real Estate Finance and Economics 18(4).
Debortoli, D, M Forni, L Gambetti and L Sala (2020), “Asymmetric Effects of
Monetary Policy Easing and Tightening”, CEPR Discussion Paper 15005.
Duca, J V, J Muellbauer and A Murphy (2021), “What Drives House Price Cycles?
International Experience and Policy Issues”, Journal of Economic Literature
59(3): 773–864.
Ehrenbergerova, D, J Bajzik and T Havranek (2023), “When Does Monetary Policy
Sway House Prices? A Meta-Analysis”, IMF Economic Review 71(2): 538–73.
Glaeser, E L and J Gyourko (2009), “Arbitrage in Housing Markets”, Housing
Markets and the Economy: Risk, Regulation, and Policy, 113–46.
Henderson, J V and Y M Ioannides (1983), “A Model of Housing Tenure Choice”,
American Economic Review 73(1): 98–113.
Jordà, Ò, M Schularick and A M Taylor (2015), “Betting the house”, Journal of
International Economics 96(S1): 2–18.
Poterba, J M (1984), “Tax Subsidies to Owner-Occupied Housing: An Asset Market
Approach”, Quarterly Journal of Economics 99(4): 729–52.
Rey, H (2015), “Dilemma not Trilemma: The Global Financial Cycle and Monetary
Policy Independence”, NBER Working Paper 21162.
Tenreyro, S and G Thwaites (2016), “Pushing on a String: US Monetary Policy Is
Less Powerful in Recessions”, American Economic Journal: Macroeconomics 8(4):
43–74.
FOOTNOTES
1. Our approach differs from that of Jorda et al. (2015) to the extent that (1)
we focus on a more recent sample better suited to our purpose, (2) we do not
restrict the analysis to countries with a fixed exchange rate, and (3) we
use as excluded instruments not only the nominal change in the US Federal
Funds Rate, but also the exogenous US monetary policy shocks (as calculated
by Gürkaynak et al. 2005).
2. Burgert et al. (2024) provide a more detailed discussion of the
appropriateness of GDP growth versus the output gap to capture the cyclical
position at the time. Results for GDP growth and the output gap are
comparable.
AUTHORS
MATTHIAS BURGERT
Senior Economist Swiss National Bank (SNB)
JOHANNES EUGSTER
Senior Economist Swiss National Bank (SNB)
VICTORIA OTTEN
Economist University Of Bonn
THEMES
* Monetary Policy
KEYWORDS
* House prices
* monetary tightening
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VoxEU Column
HOW HOUSE PRICES RESPOND TO MONETARY POLICY SURPRISES
* Marianna Kudlyak
* Augustus Kmetz
* Oleksiy Kryvtsov
* Denis Gorea
4 Nov 2022
* Financial Markets
* Monetary Policy
VoxEU Column
THE HOUSING CYCLE AND MONETARY POLICY TRANSMISSION
* Marcin Kolasa
* Michał Brzoza-Brzezina
* Paolo Gelain
* Kristina Bluwstein
7 Dec 2020
* Financial Markets
* Monetary Policy
VoxEU Column
MONETARY POLICY AND US HOUSING EXPANSIONS: WHAT WE CAN EXPECT FOR THE
POST-COVID-19 HOUSING RECOVERY
* Martin Iseringhausen
* Frederic Opitz
* Bruno Albuquerque
23 Jun 2020
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