Housing Bubbles and Interest Rates

In this paper we assess whether persistently too low interest rates can cause housing bubbles. For a sample of 14 OECD countries, we calculate the deviations of house prices from their (theoretically implied) fundamental value and define them as bubbles. We then estimate the impact that a deviation of short term interest rates from the Taylor-implied interest rates have on house price bubbles. We additionally assess whether interest rates that have remained low for a longer period of time have a greater impact on house price overvaluation. Our results indicate that there is a strong link between low interest rates and housing bubbles. This impact is especially strong when interest rates are "too low for too long". We argue that, by ensuring that rates do not deviate too far from Taylorimplied rates, central banks could lean against house price fluctuations without considering house price developments directly. If this is not possible, e.g. because a single monetary policy is confronted with a very heterogenous economic development within the currency area, alternative counter cyclical measures have to be considered.