International Capital Flows and House Prices: Theory and Evidence

Abstract

The last …fteen years have been marked by a dramatic boom-bust cycle in real estate prices, accompanied by economically large ‡uctuations in international capital ‡ows. We argue that changes in international capital ‡ows played, at most, a small role in driving house price movements in this episode and that, instead, the key causal factor was a …nancial market liberalization and its subsequent reversal. Using observations on credit standards, capital ‡ows, and interest rates, we …nd that a bank survey measure of credit supply, by itself, explains 53 percent of the quarterly variation in house price growth in the U.S. over the period 1992-2010, while it explains 66 percent over the period since 2000. By contrast, once we control for credit supply, various measures of capital ‡ows, real interest rates, and aggregate activity–collectively–add less than 5% to the fraction of variation explained for these same movements in home values. Credit supply retains its strong marginal explanatory power for house price movements over the period 2002-2010 in a panel of international data, while capital ‡ows have no explanatory power. Keywords: housing boom and bust, global savings glut, foreign capital ‡ows. JEL:F20,F32,G12,G21