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Heterogeneous Beliefs and Housing-Market Boom-Bust Cycles in a Small Open Economy

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  • Hajime Tomura

Abstract

This paper introduces heterogeneous beliefs among households in a small open economy model for the Canadian economy. The model suggests that simultaneous boom-bust cycles in house prices, output, investment, consumption and hours worked emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. With sticky prices and a standard monetary policy rule, the model shows that the nominal policy interest rate and the CPI inflation rate decline during housing booms and rise as house prices fall. These results replicate the stylized features of housing-market boom-bust cycles in industrialized countries. Policy experiments demonstrate that stronger policy responses to inflation amplify housing-market boom-bust cycles. Also, higher loan-to-value ratios amplify housing-market boom-bust cycles by encouraging speculative housing investments by mortgage borrowers during housing booms and increasing liquidation of housing collateral during housing busts.

Suggested Citation

  • Hajime Tomura, 2009. "Heterogeneous Beliefs and Housing-Market Boom-Bust Cycles in a Small Open Economy," Staff Working Papers 09-15, Bank of Canada.
  • Handle: RePEc:bca:bocawp:09-15
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Housing market boom-bust cycles and monetary policy
      by Economic Logician in Economic Logic on 2009-06-30 13:12:00

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    Cited by:

    1. Jinke Li & Geoffrey Meen, 2016. "Agent Based Models, Housing Fluctuations and the Role of Heterogeneous Expectations," Economics & Management Discussion Papers em-dp2016-09, Henley Business School, Reading University.
    2. Badarinza, Cristian & Gross, Marco, 2011. "Macroeconomic vulnerability and disagreement in expectations," Working Paper Series 1407, European Central Bank.
    3. Ng, Eric C.Y. & Feng, Ning, 2016. "Housing market dynamics in a small open economy: Do external and news shocks matter?," Journal of International Money and Finance, Elsevier, vol. 63(C), pages 64-88.
    4. Tomura, Hajime, 2010. "International capital flows and expectation-driven boom-bust cycles in the housing market," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1993-2009, October.

    More about this item

    Keywords

    Credit and credit aggregates; Financial stability; Inflation targets;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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    1. Economic Logic blog

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