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When is a housing market overheated enough to threaten stability?

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  • John Muellbauer

Abstract

In many countries, house prices are subject to boom/bust cycles and in some these are linked to severe economic and financial instability. Overheating can have both a price and a quantity dimension, but it is likely that they are linked by common drivers. However, much depends on the land-use planning regime which profoundly affects the supply response. It is helpful to make the distinction between overshooting of house prices due to extrapolative expectations and 'frenzy', given fundamentals, and shifts in possibly fragile fundamentals. The contribution of careful econometric modelling to estimating the effects of the former is demonstrated: central banks or other policy makers should institute quarterly surveys of house price expectations of potential housing market participants to help assess the first type of overshooting. Assessing the fragility or otherwise of the economic fundamentals is more complex. Credit supply conditions in the mortgage market are the 'elephant in the room'. Without taking a credit conditions measure into account, one simply cannot understand the behaviour of house prices, housing debt and consumption in countries such as Australia, the UK, the US, South Africa or France or understand vulnerability of some economies to high levels of household debt. Other financial and economic indicators of vulnerability are discussed, including high bank leverage ratios, high ratios of loans to deposits, debt, deficit and current account of ratios. Models of early warning of financial and economic crises estimated on large country panels need to be quite complex, for example, including some important interaction effects since shock transmission is very institution dependent.

Suggested Citation

  • John Muellbauer, 2012. "When is a housing market overheated enough to threaten stability?," Economics Series Working Papers 623, University of Oxford, Department of Economics.
  • Handle: RePEc:oxf:wpaper:623
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    More about this item

    Keywords

    Financial crisis; Financial accelerator; House price determination; Credit boom; Credit standards; Subprime mortgages; User cost; Risk premia; Construction boom;
    All these keywords.

    JEL classification:

    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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