House Prices, Collateral Effects and Sectoral Output Dynamics in Emerging Market Economies

Abstract

This paper studies the channels through which house prices a¤ect sectoral output in emerging market economies, focusing on the role of collateral and borrowing dynamics. We first show that relative to the tradable sector, nontradable sector output is more strongly correlated with house prices and its response to a house price shock in a Panel VAR is larger for a sample of emerging market economies. Then, we study the model dynamics generated by shocks to housing demand in a two-sector small open economy real business cycle model. The results show that housing demand shocks lead to a sectoral reallocation by inducing an expansion in the nontradable sector and a contraction in the tradable sector. The model successfully generates the comovement between the cycle and house prices, matching the strong positive correlation of house prices and nontradable output. We also study the importance of collateral e¤ects for the model dynamics and show that the collateral channel is key to generating the correlations between house prices and sectoral output observed in the data.