Monetary Policy and the House Price Boom across U.S. States

Abstract

Abstract: The authors use a dynamic factor model estimated via Bayesian methods to disentangle the relative importance of the common component in the Office of Federal Housing Enterprise Oversight's house price movements from state- or region-specific shocks, estimated on quarterly state-level data from 1986 to 2004. The authors find that movements in house prices historically have mainly been driven by the (state- or region-specific) component. The recent period (2001-04) has been different, however: Local bubbles have been important in some states, but overall the increase in house prices is a phenomenon. The authors then use a VAR to investigate the extent to which expansionary monetary policy is responsible for the common component in house price movements. The authors find the impact of policy shocks on house prices to be very small. JEL classification: C11, E58, R31 Key words: housing, monetary policy, Bayesian analysis 1 Introduction In some U.S. metropolitan areas house prices increased dramatically during the last few years. The increase in house prices is substantial even if one looks at the average state-level price, which smooths out the differences across markets within each state. Figure 1 shows the annualized average growth rates from the first quarter of 2001 to the last quarter of 2004 in the OFHEO (Office of Federal Housing Enterprise Oversight) house price indexes, deflated by the U.S. core PCE inflation, for the forty-eight contiguous states. In this four-year period house price indexes increased more then ten percent per year in several states on both the East and the West Coasts, notably California, Florida, Nevada, Maryland and Rhode Island. The rise in house prices has been very uneven across the nation, with some states, like Texas and Ohio, growing barely above two percent per year. If we compare the growth in house prices in the last four years with the average growth since 1986, we find that states like Florida have grown three times their average, while other states, like Michigan, have grown twenty percent less than average. [FIGURE 1 OMITTED] From the perspective of the current debate, an important question is whether the widespread, but not homogeneous, increase in house prices reflects a phenomenon or rather, in the words of Chairman Greenspan, a collection of local bubbles. The answer to this question has important policy implications. Local bubbles are most likely attributable to factors, i.e., circumstances that are specific to each geographic market, rather than to monetary policy, which is the same for the entire nation. On the contrary, if the boom in house prices is a phenomenon, monetary policy may well be a likely suspect. To address the issue of a potential housing cycle we estimate a dynamic factor model in the spirit of Geweke (1977), Sargent and Sims (1977), and Stock and Watson (1989), on state-level OFHEO house price indexes from the mid-eighties to the end of 2004. We then use the factor model to disentangle the component of the increase in the value of housing that is common to all states from the component that is idiosyncratic, i.e. specific to each state. The latter component is meant to capture the local bubbles, while the former captures co-movement across all states, and therefore, potentially, what has been referred to as a national bubble. We find that historically movements in house prices have mainly been driven by the (state- or region-specific) component. Indeed, growth rates in OFHEO house price index are far less synchronized across states than are the growth rates in real per capita income, which are a measure of the business cycle at the state level. However, the recent period has been different in this regard. While for a number of states factors are still very important, for many states that experienced large increases in house prices a substantial fraction of these increases is attributable to the factor. …