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House price booms and the current account

Adam, Klaus and Kuang, Pei and Marcet, Albert (2012) House price booms and the current account. NBER Macroeconomics Annual, 26 (1). pp. 77-122. ISSN 0889-3365

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Identification Number: 10.1086/663990

Abstract

A simple open economy asset pricing model can account for the house price and current account dynamics in the G7 over the years 2001-2008. The model features rational households, but assumes that households entertain subjective beliefs about price behavior and update these using Bayes' rule. The resulting beliefs dynamics considerably propagate economic shocks and crucially contribute to replicating the empirical evidence. Belief dynamics can temporarily delink house prices from fundamentals, so that low interest rates can fuel a house price boom. House price booms, however, are not necessarily synchronized across countries and the model is consistent with the heterogeneous response of house prices across the G7 following the reduction in real interest rates at the beginning of the millennium. The response to interest rates depends sensitively on agents' beliefs at the time of the interest rate reduction, which in turn are a function of the country-specific history prior to the year 2000. According to the model, the US house price boom could have been largely avoided if real interest rates had decreased by less after the year 2000.

Item Type: Article
Official URL: http://www.nber.org/books/acem12-2
Additional Information: © 2012 National Bureau of Economic Research
Subjects: H Social Sciences > HC Economic History and Conditions
Sets: Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 20 Sep 2012 12:26
Last Modified: 16 Apr 2013 08:50
URI: http://eprints.lse.ac.uk/id/eprint/46214

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