Financial Accelerator in Action : Economic Fundamentals, Real Estate Dynamics, and Business Cycles in Japan

Using the test case of Japan during 1980 to 2000, this paper quantitatively explores a trinity of issues: (a) role of time variations in aggregate productivity and land taxation policy on real estate market fluctuations, (b) extent of spillover from the real estate market to the aggregate economy, and (c) given the preponderance of real-estate backed lending practices, the significance of the financial accelerator mechanism in turning small shocks to the real estate market into an amplified and prolonged business cycles. Using a fully calibrated, dynamic general equilibrium model, the paper finds that fluctuations in productivity and land taxes account well for fluctuations in output and land redistribution between commercial and residential uses. Land prices, on the other hand, are very sensitive to agents' expectations about persistence of the initial shocks. A comparison of the benchmark model with an alternative where credit constraints are exogenously determined numerically establishes the power of the financial accelerator in amplifying and prolonging a business cycle