Abstract
This study uses theoretical models and empirical research to explain that interest rates affect the structure of housing price formation and correction rather than affect the price alone. In particular, when interest rates are substantially reduced, the correction of housing prices toward fundamentals is absent; in other words, a housing bubble is likely to occur. This study first illustrates a model for explaining home price behavior. Data from the Case-Shiller U.S. National Home Price Index between January 1975 and August 2020 are adopted to observe the behavior of home prices. The empirical results show that the correction and bubble behavior of U.S. home prices have exhibited significant structural changes. Variation in money supply fails to explain the structural changes, however, interest rate variation can significantly affect the structural changes. According to the results, when interest rates rise or fall slightly, the correction of home prices toward the equilibrium value is significant. However, when interest rates fall substantially, the bubble behavior of home prices is significant. For governments that adopt low interest rates to revitalize the economy, the results of this study provide special reference values. Governments should provide additional intervention in housing markets when an extremely low interest rate exists.
Highlights
The effect of monetary policy on home prices has been a crucial research topic in recent years
This study establishes a model for explaining home price behavior, and subsequently hypothesizes that two situations, namely, the failure to adjust the expectation of rational bubbles in time and the existence of rent rigidity, would change home price bubbles or correction behavior
Different from previous literature, this study argues that interest rates affect the rise or fall of home prices, but may induce structural changes in home prices
Summary
The effect of monetary policy on home prices has been a crucial research topic in recent years. The two reasons only account for the effects of interest rates on reasonable home prices and fail to explain why interest rate changes cause an unbalanced housing market (i.e., bubbles) and irrational home price behavior. If money supply considerably increases and fails to flow into real economic activities, it leads to excess liquidity In this situation, the market has excessive money for an insufficiently low number of houses, creating home price bubbles. Interest rates and liquidity affect housing markets on different levels, which probably explains why previous studies have mainly identified liquidity as the factor of home price bubbles. The results in this article are more important for observing the effects of the “atypical” monetary policy after 2020; the research results warn that if governments continue to use extremely low-interest rates, they will undermine the stability of the housing market.
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