The booms and busts of real estate prices echo those of the real business cycle. This column looks at the relationship between house price valuations and economic growth in an international context. Taking account of heterogeneity in housing policies across countries, large house price depreciations are found to be positively associated with economic growth.
Rising housing prices are accompanied by higher household consumption and firm investment that boost economic growth. However, excessive house price appreciations may distort capital allocation efficiency, for example by crowding out investments in productive sectors, which reduce long-term economic growth. Moreover, house price bubbles are typically unsustainable. Once a housing bubble bursts, credit conditions will tighten due to falling collaTerral value, leading to a fall in household consumption and employment that cause an economic downturn. Meanwhile, the correction of housing prices may improve investment efficiency and trigger structural reform that subsequently enhances economic growth.
Figure 1 shows that appreciations of housing prices can be translated into higher growth in real GDP, real GDP per capita and total factor productivity (TFP). This positive relation between house price appreciations and economic growth remain robust, even after filtering the economic growth attributed to the increase in consumption, investment, employment, and credit allocation that partially benefit from rising house prices. In particular, a 10% increase in house price appreciation is associated with 0.2% higher economic growth. Accounting for the indirect effect of house price through consumption, investment and employment further strengthen the association between house appreciations and economic growth.
Figure 1. Summary of associations with growth
While large house price depreciations are associated with lower levels of consumption, investment, and employment that undermine economic growth, it can trigger capital allocation efficiency and labour mobility that benefits growth. First of all, credit is reallocated to more efficient firms after a crisis (Borensztein and Lee 2002). Second, steep housing price corrections force zombie firms out of the market, which allows banks to lend more efficiently than committing loans to unproductive zombie firms (Caballero et al. 2008)
There are significant variations across countries. Such a relation is the strongest in Hong Kong – in the absence of housing price cycles, the economic growth in Hong Kong would have been lower by 67 basis points per year. Cumulated over several years this can have a significant impact on long-term economic growth. On average, the housing price cycles add 26–35 basis points to economic growth annually. Given our sample periods, the contribution of housing valuations to economic growth is negative in Germany and Japan, although the magnitudes are relatively small.
Figure 2. Average contribution of housing cycles to GDP growth (%)
The below picture figuratively explains “A consumption cycle”
The below figure shows Maximum Consumption of a couple earning 35 lakhs ($50K) per annum
