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House Price Booms and the Current Account

In: NBER Macroeconomics Annual 2011, Volume 26

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  • Klaus Adam
  • Pei Kuang
  • Albert Marcet

Abstract

A simple open economy asset pricing model can account for the house price and current account dynamics in the G7 over the years 2001-2008. The model features rational households, but assumes that households entertain subjective beliefs about price behavior and update these using Bayes' rule. The resulting beliefs dynamics considerably propagate economic shocks and crucially contribute to replicating the empirical evidence. Belief dynamics can temporarily delink house prices from fundamentals, so that low interest rates can fuel a house price boom. House price booms, however, are not necessarily synchronized across countries and the model correctly predicts the heterogeneous response of house prices across the G7, following the fall in real interest rates at the beginning of the millennium. The response to interest rates depends sensitively on agents' beliefs at the time of the interest rate reduction, which are a function of the prior history of disturbances hitting the economy. According to the model, the US house price boom could have been largely avoided, if real interest rates had decreased by less after the year 2000.

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This chapter was published in:

  • Daron Acemoglu & Michael Woodford, 2012. "NBER Macroeconomics Annual 2011, Volume 26," NBER Books, National Bureau of Economic Research, Inc, number acem11-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12408.

    Handle: RePEc:nbr:nberch:12408

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    References

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    1. Charles Himmelberg & Christopher Mayer & Todd Sinai, 2005. "Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions," NBER Working Papers 11643, National Bureau of Economic Research, Inc.
    2. David Laibson & Johanna Mollerstrom, 2010. "Capital Flows, Consumption Booms and Asset Bubbles: A Behavioural Alternative to the Savings Glut Hypothesis," Economic Journal, Royal Economic Society, vol. 120(544), pages 354-374, 05.
    3. Glaeser, Edward L. & Gyourko, Joseph & Saiz, Albert, 2008. "Housing supply and housing bubbles," Journal of Urban Economics, Elsevier, vol. 64(2), pages 198-217, September.
    4. Kiminori Matsuyama, 1990. "The Mathematical Appendix to Residential Investment and the Current Account," Discussion Papers 875, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    5. Aizenman, Joshua & Jinjarak, Yothin, 2008. "Current account patterns and national real estate markets," Santa Cruz Department of Economics, Working Paper Series qt1rh4s127, Department of Economics, UC Santa Cruz.
    6. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
    7. Klaus Adam & Albert Marcet & Juan Pablo Nicolini, 2006. "Learning and Stock Market Volatility," Computing in Economics and Finance 2006 15, Society for Computational Economics.
    8. Matsuyama, Kiminori, 1990. "Residential investment and the current account," Journal of International Economics, Elsevier, vol. 28(1-2), pages 137-153, February.
    9. Sergio Rebelo & Martin Eichenbaum & Craig Burnside, 2012. "Understanding Booms and Busts in Housing Markets," 2012 Meeting Papers 114, Society for Economic Dynamics.
    10. Klaus Adam & Albert Marcet, 2011. "Internal Rationality, Imperfect Market Knowledge and Asset Prices," CEP Discussion Papers dp1068, Centre for Economic Performance, LSE.
    11. Topel, Robert H & Rosen, Sherwin, 1988. "Housing Investment in the United States," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 718-40, August.
    12. Monika Piazzesi & Martin Schneider, 2009. "Momentum traders in the housing market: survey evidence and a search model," Staff Report 422, Federal Reserve Bank of Minneapolis.
    13. Joseph Gyourko & Eduardo Morales & Charles Nathanson & Edward Glaeser, 2011. "Housing Dynamics," 2011 Meeting Papers 307, Society for Economic Dynamics.
    14. Hanno Lustig & Stijn Van Nieuwerburgh, 2003. "Housing Collateral, Consumption Insurance and Risk Premia: An Empirical Perpective," NBER Working Papers 9959, National Bureau of Economic Research, Inc.
    15. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, vol. 54(5), pages 1129-60, September.
    16. Gete, Pedro, 2009. "Housing Markets and Current Account Dynamics," MPRA Paper 20957, University Library of Munich, Germany, revised 24 Feb 2010.
    17. Klaus Adam & Albert Marcet, 2011. "Booms and Busts in Asset Prices," CEP Discussion Papers dp1059, Centre for Economic Performance, LSE.
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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Near rational agents and house price booms
      by Economic Logician in Economic Logic on 2011-09-12 14:17:00
    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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    Cited by:
    1. Enrique G. Mendoza & Emine Boz, 2009. "Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis," 2009 Meeting Papers 1273, Society for Economic Dynamics.
    2. Andrea Ferrero, 2012. "House price booms, current account deficits, and low interest rates," Staff Reports 541, Federal Reserve Bank of New York.
    3. Sandra Gomes & Caterina Mendicino, 2011. "Housing Market Dynamics: Any News?," Working Papers w201121, Banco de Portugal, Economics and Research Department.
    4. Eleonora Granziera & Sharon Kozocki, 2012. "House Price Dynamics: Fundamentals and Expectations," Working Papers 12-12, Bank of Canada.
    5. Jack Favilukis & David Kohn & Sydney C. Ludvigson & Stijn Van Nieuwerburgh, 2012. "International Capital Flows and House Prices: Theory and Evidence," NBER Chapters, in: Housing and the Financial Crisis National Bureau of Economic Research, Inc.
    6. Peter Tillmann, 2012. "Capital Inflows and Asset Prices: Evidence from Emerging Asia," MAGKS Papers on Economics 201215, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    7. Edward L. Glaeser, 2011. "Comment on "House Price Booms and the Current Account"," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 123-131 National Bureau of Economic Research, Inc.
    8. Lars Peter Hansen, 2011. "Comment on "House Price Booms and the Current Account"," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 132-143 National Bureau of Economic Research, Inc.
    9. Paul Bergin, 2011. "Asset price booms and current account deficits," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue Dec. 5.

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