House Prices Booms and Current Account Deficits
One of the most striking features of the period before the Great Recession of 2007-2009 is the strong positive correlation between house price appreciation and current account deficits in countries that have subsequently experienced the highest degree of financial turmoil. A progressive relaxation of credit constraints can rationalize this empirical observation. Lower collateral requirements facilitate access to external funding and drive up house prices. Households increase their leverage borrowing from the rest of the world so that the current account turns negative. Several pieces of evidence support this view. The paper further compares this mechanism with the role of monetary policy, the exchange rate regime and foreign saving shocks in accounting for the evidence.
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