Low interest rates and housing booms: the role of capital inflows, monetary policy and financial innovation

A number of OECD countries experienced an environment of low interest rates and a rapid increase in housing market activity during the last decade. Previous work suggests three potential explanations for these events: expansionary monetary policy, capital inflows due to a global savings glut and excessive financial innovation combined with inappropriately lax financial regulation. In this study we examine the effects of these three factors on the housing market. We estimate a panel VAR for a sample of OECD countries and identify monetary policy and capital inflows shocks using sign restrictions. To explore how these effects change with the structure of the mortgage market and the degree of securitisation, we augment the VAR to let the coefficients vary with mortgage market characteristics. Our results suggest that both types of shocks have a significant and positive effect on real house prices, real credit to the private sector and real residential investment. The responses of housing variables to both types of shocks are stronger in countries with more developed mortgage markets, roughly doubling the responses to a monetary policy shock. The amplification effect of mortgage-backed securitisation is particularly strong for capital inflows shocks, increasing the response of real house prices, residential investment and real credit by a factor of two, three and five, respectively.