The dynamics of housing demand under a linked-exchange rate system

Abstract

A recovering economy, along with loose credit in the wake of the U.S. quantitative easing (QE) measures, has boosted Hong Kong's economic activities in the last couple of years. Nonetheless, it is not altogether positive, as Hong Kong, under the linked exchange rate system (to the U.S. dollar), essentially does not have its own monetary policy, and is thus highly susceptible not only to U.S. monetary policies but also to hot money from abroad. The latter helps create a more uncertain, and riskier, market environment. In response, investors' portfolio selections change, and financial institutions adjust the supply of loans which essentially determines consumption and investment behaviours, including housing demand. In light of such an intertwined nature between these markets, this paper, using a vector autoregression (VAR) model, examines the inter-relationships between housing transaction volume and a variety of factors, such as money supply, housing price, banks' loan-to-deposit ratio, stock market returns, and best lending rate. The findings reveal that all those factors do have a one-directional long-run relationship with transaction volume, and that shocks in property price contribute the most to the forecast errors of property transactions. Interestingly, housing transaction volume responds to shocks in money supply negatively, rather than positively as usually reported in western literature. The reason can be attributed to the fact that the supply of money in Hong Kong, due to the linked exchange rate, is primarily subjected to the influx of hot money; and that investors, in response, prefer the stock market for its liquidity and lower cost over the property market. Then, as stock price increases, so does housing demand (transaction volume) due to the wealth effect. Policy implications, with reference to such effect, are then discussed.