What causes housing bubbles? A theoretical and empirical inquiry

The paper investigates in how far lax monetary policy (defined as deviations fromprescriptive monetary policy rules or past trends) and/or financial innovation can be seenas a cause for housing price bubbles in industrialized countries. From a theoreticalperspective, it is found that there are hardly any clearly formulated economic models whichassign a role to lax monetary policy in bubble formation, while there are a number ofmodels which assign a role to financial innovation or liberalization. In the empirical part,the paper first presents cross-country-time-series SUR regressions for a sample of 16industrialized countries. According to the results, there is no robust, significant role for therelevance of loose monetary policy, measured by deviations from the Taylor rule. Instead,deviations from the past trend of the real policy rate affect housing prices, but the size ofthe effect depends on the regulation and development of the financial sector. In a thirdstep, three case studies of the United States, Austria and the United Kingdom arepresented, representing countries which have experienced a) lax monetary policy and abubble b) lax monetary policy without a bubble and c) no deviation from the Taylor ruleand a bubble. The case studies hint that specific changes in regulations played a role forthe emergence or absence of bubbles, yet these regulations might not be appropriatelycovered by standard quantitative indicators for financial market (de-)regulation.