The knotty interplay between credit and housing

Abstract

We employ the recent Jordà, Schularick, and Taylor (2016) and Knoll, Schularick, and Steger (2017) datasets to investigate the long-run relationship between house prices and credit volume, allowing for interest rate, real exchange rate and real gross domestic product (GDP). We refine the analysis using data at the quarterly-level to define relevant co-integrating relationships across a number of European economies. Housing, GDP and credit cross-sectional averages are included in the analysis to detect the effects of common factors. Empirical results indicate the presence of cross-country heterogeneities and an uneven feedback mechanism between credit and housing – the full loop is established only for several countries in the dataset. Grouping countries for panel-like econometric exercises may lead to spurious regression results, poor inference and misleading policy implications. Short-run dynamics, compared to the long-run may often lead to contradicting policy advice if the order of integration of the house price series is not properly accounted for. Furthermore, the presence of spatial patterns of house prices and credit highlight the need to consider global housing and credit developments for national policy making.