Financial integration and house price dynamics in equilibrium modeling of intra-EMU and global trade imbalances

A dramatic decline of EMU periphery's and the US saving rate, house price booms and huge global and intra-EMU trade imbalances characterize the evolution of the world economy since Euro-related intra-EMU and global financial integration after the East-Asian currency crisis up to the onset of the global financial crisis. While the intra-EMU and global trade imbalances and the huge level differences between Asian and US saving rates can be explained by means of Farmer and Mihaiescu's (2016) three-country, three-good OLG model with financial constraints and growth rate differentials, the pronounced decline in EMU periphery’s and in the US saving rate cannot. It is natural to suggest that house price booms in EMU periphery and in the US boosted consumption and reduced savings. Thus, this paper introduces house price dynamics à la Arce and López-Salido (2011) and Basco (2014) into Farmer and Mihaiescu's (2016) intertemporal equilibrium model, and finds that house price increases let EMU periphery’s and US saving rates indeed decline more quickly – in line with empirical facts.