The Effects of Monetary Policy on House Prices in Spain: the role of the economic and monetary union membership in the housing bubble prior to the great recession

Abstract

Aim: This paper aims to discover the evolution of monetary transmission in Spain by focusing on the short-term interest rate, credit aggregates and house prices through different stages of economic development and European integration between 1975 and 2008. In addition, the analysis devotes special attention to the interval of the last housing boom, in order to reveal the importance of the interest rate policy of the ECB.Design / Research methods: The study applies a tri-variate autoregressive model assigned to three overlapping periods outlined by regime shifts in the Spanish economy. The estimation output determines the strength and persistency of the links between interest rates, credit aggregates and house prices. Consequently, the results of the econometric analysis provide proper base for comparison in order to identify the dominating channels of monetary transmissions through a prolonged period.Conclusions / findings: It is found that the transmission mechanism in Spain essentially altered over time since 1975. At the beginning of the full analysed interval the role of the credit channel was dominant, then its importance gradually diminished. After the EMU accession the traditional interest rate channel became the leading factor with an intensified and more persistent effect on house prices.Originality / value of the article: While there are numerous researches aimed at estimating the impact of monetary policy on the real economy, empirical studies focusing exclusively on the link between interest rate policy and house prices in Spain are still rare. As the present paper concentrates solely on the Spanish characteristics through extended interval, the study provides country-specific inferences.Implications of the research: Understanding the mechanism of the monetary policy effects on the housing sector is an essential aspect of designing policy interventions aimed at keeping house price development in check.Limitations of the research: Despite the significant results of the empirical analysis, the excessively dynamic increase in the property prices suggests that the factor of irrational expectations also played important role in the latest Spanish housing bubble.Key words: Monetary policy, VAR, ECB, Housing boom, Monetary transmission mechanismJEL: E52, E58.