The housing market plays a crucial role in the overall economy, with rising house prices often leading to increased household consumption and firm investment, thereby boosting economic growth. However, excessive house price appreciations can distort capital allocation efficiency and potentially hinder long-term economic growth. Additionally, housing bubbles are typically unsustainable, and when they burst, it can lead to a tightening of credit conditions, resulting in a decline in household consumption and employment, ultimately causing an economic downturn. Despite these challenges, the correction of housing prices can improve investment efficiency and trigger structural reforms that subsequently enhance economic growth.
In this article, we will explore the relationship between economic growth and real estate prices, drawing insights from various reports and working papers. We will examine the impact of both appreciations and depreciations in house prices on economic growth, the trade-offs involved, and the cross-country differences in this relationship. Additionally, we will discuss the duration of housing cycles and their contributions to GDP growth in different countries. By delving into these topics, we aim to gain a deeper understanding of the complex dynamics between economic growth and real estate prices.
Appreciations versus Depreciations
The relationship between house price appreciations and economic growth is generally positive. Studies have shown that a 10% increase in house price appreciation can be associated with a 0.2% higher economic growth. This association holds true even after considering the indirect effects of rising house prices, such as increased consumption, investment, employment, and credit allocation, which partially benefit from the appreciation of house prices.
On the other hand, the relationship between house price depreciations and economic growth is nonlinear and depends on the depth and speed of price correction. Moderate house price depreciations, characterized by a modest and prolonged decline in house prices, are negatively associated with economic growth in terms of real GDP and GDP per capita. However, large depreciations, characterized by a sharp and quick drop in house prices, are positively associated with stronger growth in economic output and productivity. This finding aligns with previous research that highlights the asymmetric impacts of large and moderate house price depreciations on economic activity.
Large house price depreciations, while associated with lower levels of consumption, investment, and employment that can undermine economic growth, can also trigger improvements in capital allocation efficiency and labor mobility. After a crisis, credit tends to be reallocated to more efficient firms, while zombie firms are forced out of the market. Additionally, large depreciations increase the number of underwater mortgages, which in turn enhances labor mobility as households seek better labor markets. These improvements in capital allocation efficiency and labor mobility contribute to economic growth.
Cross-Country Differences
The strength of the relationship between large house price depreciations and economic growth varies across countries due to differences in legal systems and safety nets. In countries with stronger safety nets provided through mortgage insurance and personal bankruptcy law, the consequences of large house depreciations are less severe. In such cases, significant structural changes that motivate reshuffles in capital and the labor market are less likely to occur.
The average duration of housing appreciations and depreciations in a typical housing cycle is approximately six and five years, respectively. The contribution of a typical housing cycle to GDP growth varies across countries, with significant variations observed. For example, the positive impact of housing cycles on GDP growth is particularly strong in Hong Kong, where the absence of housing price cycles would have resulted in lower economic growth. On average, housing price cycles add 26-35 basis points to economic growth annually. However, there are exceptions, such as Germany and Japan, where the contribution of housing valuations to economic growth is negative, albeit relatively small in magnitude.
The relationship between economic growth and real estate prices is complex and multifaceted. While house price appreciations are generally associated with output growth, house price depreciations can either undermine or stimulate growth, depending on the depth of correction and the market environment. Large house price depreciations, in the absence of banking crises, can lead to strong recovery in growth and facilitate improvements in capital allocation efficiency and labor mobility. However, the impact of large house depreciations on economic growth is contingent upon the presence of a robust safety net and legal framework.
Understanding the dynamics between economic growth and real estate prices is crucial for policymakers and market participants. It highlights the importance of monitoring housing market developments and implementing appropriate measures to mitigate risks associated with excessive price appreciations or depreciations. By striking a balance between promoting economic growth and maintaining stability in the housing market, policymakers can foster sustainable and resilient economies.