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Housing Bubbles and Interest Rates

  • Christian Hott
  • Terhi Jokipii

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.

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Paper provided by Swiss National Bank in its series Working Papers with number 2012-07.

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Length: 47 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:snb:snbwpa:2012-07
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  1. George A. Kahn, 2010. "Taylor rule deviations and financial imbalances," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 63-99.
  2. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  3. Dubecq, S. & Mojon, B. & Ragot, X., 2009. "Fuzzy Capital Requirements, Risk-Shifting and the Risk Taking Channel of Monetary Policy," Working papers 254, Banque de France.
  4. Christian Hott & Pierre Monnin, 2008. "Fundamental Real Estate Prices: An Empirical Estimation with International Data," The Journal of Real Estate Finance and Economics, Springer, vol. 36(4), pages 427-450, May.
  5. John B. Taylor, 2009. "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong," NBER Working Papers 14631, National Bureau of Economic Research, Inc.
  6. Ouarda Merrouche & Erlend Nier, 2010. "What Caused the Global Financial Crisis; Evidenceon the Drivers of Financial Imbalances 1999: 2007," IMF Working Papers 10/265, International Monetary Fund.
  7. Yener Altunbas & Leonardo Gambacorta & David Marques-Ibanez, 2010. "Does monetary policy affect bank risk-taking?," BIS Working Papers 298, Bank for International Settlements.
  8. Jonathan McCarthy & Richard W. Peach, 2004. "Are home prices the next "bubble"?," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-17.
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