What causes housing bubbles? A theoretical and empirical inquiry

The paper investigates in how far lax monetary policy (defined as deviations from prescriptive monetary policy rules or past trends) and/or financial innovation can be seen as a cause for housing price bubbles in industrialized countries. From a theoretical perspective, it is found that there are hardly any clearly formulated economic models which assign a role to lax monetary policy in bubble formation, while there are a number of models which assign a role to financial innovation or liberalization. In the empirical part, the paper first presents cross-country-time-series SUR regressions for a sample of 16 industrialized countries. According to the results, there is no robust, significant role for the relevance of loose monetary policy, measured by deviations from the Taylor rule. Instead, deviations from the past trend of the real policy rate affect housing prices, but the size of the effect depends on the regulation and development of the financial sector. In a third step, three case studies of the United States, Austria and the United Kingdom are presented, representing countries which have experienced a) lax monetary policy and a bubble b) lax monetary policy without a bubble and c) no deviation from the Taylor rule and a bubble. The case studies hint that specific changes in regulations played a role for the emergence or absence of bubbles, yet these regulations might not be appropriately covered by standard quantitative indicators for financial market (de-)regulation.