Housing Price Cycles, Current Account Imbalances and Institutions

Abstract

Recorded in history the 2007-2008 crisis is accepted to be the most serious crisis experienced after the 1929 Great Depression. This crisis began in the US. subprime mortgage markets and impacted not only the financial and real sectors in the US, but quickly became a global crisis, especially because of financial liberalization. The financial liberalization lead that the economies are increasingly integrated into international markets. Although it has presented some advantages for the economy (eg. reducing the cost of capital, raising, increasing in credit availability), it has had the role in happening some problems. Starting with the 1990s, many countries experienced an unprecedented increase in current account imbalances. Some countries appear to have current account deficits (eg. Greece, and Portugal), others have current account surplus (eg. Germany and Netherland).On the other hand, there has been an increase in asset prices, especially in housing prices within the same time period. From 2000 to 2006, house prices rose 50% in real terms in the advanced economy while they went up by almost 30% in the developing country. Again around the same time, the ‘housing boom’ has turned into a ‘bust’ in many countries and most of them have experienced deep crisis. The cost of experiencing both housing price boom-bust cycles and high current deficits concurrently has been more severe for some of them. Consequently, it can be suggested that the current account imbalances and housing price boom-bust cycles have become the defining characteristics of the period of pre-global crisis. In addition, it is seen that although the developments in the markets show similar trends in many countries, they have had the distinct characteristics. The institutional features of the economy have potential to contribute to this differentiation. However, based on literature review, there is no study on the role of institutional features in the relationship between house price dynamics and current account imbalances. The aim of the study is to examine the relationship between housing price cycles and current account imbalances as well as the role of the institutional characteristics in this relationship. For this aim, we use a simulataneous equation model. The findings show that there is a positive association between both dynamics and that the institutions affect this relationship.