House Price Comovements in the Eurozone Economies

Abstract

1. Introduction International transmission of house price changes appears to be a natural corollary of an increasingly internationalized and interdependent financial environment. In addition, parallel movements in borrowing conditions and macroeconomic fundamentals are expected to strengthen the tendency of international house prices to comove. This should be particularly true in the case of the euro-zone, where the currency is common and monetary policy is conducted by the European Central Bank on behalf of all members. Since the mid-1990s, in particular, the housing prices of major European economies have been strongly increasing and this increase has been largely associated with high growth rates experienced over the last decade. However, recently such comovement has been blamed for triggering the latest global financial crisis. Housing as a non-traded good is not easily substituted among different countries. Over the last decade it has been claimed that major European countries' housing markets have been overvalued and that housing spillover effects appeared not only within an economy but also across economies. Two main differences stand out in the behavior of real assets like residential housing as opposed to financial markets assets like shares and bonds. First it is possible to use the information included in housing prices to make returns in excess of a buy and hold strategy i.e the efficient market hypothesis does not hold and second the housing prices are less flexible downwards compared with stocks. So the risk-return profile of an asset like residential housing makes it more attractive to investors. This paper sets out to investigate the factors underlying the apparent comovement of housing prices of the largest Euro zone economies. Specifically, we will examine first the relative importance of local factors (income, interest and stock prices) in explaining house price movements on a national level. Doing that, we differentiate between pre- and post-Euro periods and distinguish between economic expansions and contractions. We then look at the existence of spillover effects of shocks from both German monetary policy and volatility in its home housing market to the real house prices of the other countries in the Euro zone. Finally, we investigate the impact of global shocks such as emanating from changes in the US monetary policy on the volatility of each country's housing market. Using monthly data from DSI Statistical Bases for 1990(1)-2009(4), we investigate first whether there is overvaluation in real house prices across seven Euro zone economies. The economies examined namely Austria, Finland, France, Germany, Italy, the Netherlands, and Spain, constitute the core of the Euro zone, and are responsible for 90% of the zone's GDP and making up the second largest economy in the world after the US. Next, we concentrate on the impact of the adoption of the common currency on real house prices movements. We conduct the analysis using country-specific macroeconomic variables and then extend it by adding foreign-specific macro variables to each country's model. The empirical analysis includes cointegration analysis and VAR specifications. The rest of the paper is organized as follows: A brief survey of related literature is conducted in section 2. Section 3 presents stylized facts from each country's housing market. Section 4 outlines the methodology employed in the paper and includes the data description and variable selection. Section 5 presents and discusses the empirical findings. Concluding remarks are made in section 6. 2. Review of the Literature A number of studies have indicated comovement of house price changes, mainly attributed to synchronization of monetary policy, financial liberalization, integration of international financial markets, as well as global business cycle linkages (see, for example, Helbling and Terrones, 2003; Tsatsaronis and Zhu, 2004; Scanlon et al. …