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House Price Booms and the Current Account

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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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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1064.

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Date of creation: Jul 2011
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Handle: RePEc:cep:cepdps:dp1064

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Keywords: interest rates; house prices; short-term capital movements;

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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.
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  10. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 2011. "Understanding Booms and Busts in Housing Markets," CEPR Discussion Papers 8232, C.E.P.R. Discussion Papers.
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  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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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
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Cited by:
  1. Sandra Gomes & Caterina Mendicino, 2011. "Housing Market Dynamics: Any News?," Working Papers w201121, Banco de Portugal, Economics and Research Department.
  2. Edward L. Glaeser, 2011. "Comment on "House Price Booms and the Current Account"," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26 National Bureau of Economic Research, Inc.

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