Advertisement

Open Economies Review

, Volume 30, Issue 2, pp 375–402 | Cite as

Expectations and Macro-Housing Interactions in a Small Open Economy: Evidence from Korea

  • Fabio MilaniEmail author
  • Sung Ho Park
Research Article
  • 66 Downloads

Abstract

This paper studies the interaction between the housing sector and the macroeconomic environment in Korea. Besides serving as a typical small open economy, Korea provides an interesting laboratory case, since the country was subject to various housing-cycle phases over the sample, and its policymakers implemented active policies to stabilize the housing market. We present a microfounded open-economy model extended to incorporate a housing sector. The model is estimated using Bayesian methods and a large set of observables. We highlight the role of assumptions about house-price expectations on economic dynamics. In the benchmark case of rational expectations, the spillovers from housing to macro variables are modest. House prices are largely driven by sector-specific demand and supply shocks. Business cycle fluctuations are mostly driven by open-economy shocks. When the assumption of rational expectations is relaxed in favor of extrapolative expectations, however, the impact of the housing sector increases. Macroeconomic spillovers from the housing market become more important, with housing shocks accounting for up to twenty percent of fluctuations in the broader economy.

Keywords

Housing market-macroeconomy nexus House prices Non-rational expectations Macroprudential policies Household credit Small open economy model Korea’s economy 

JEL Classification

E03 E32 E58 F41 R30 

Notes

Acknowledgments

We would like to thank seminar participants at the Bank of Korea for comments. Professor Milani acknowledges and is grateful for the financial support provided by the Bank of Korea regarding this research project.

References

  1. Aoki K, Proudman J, Vlieghe G (2004) House prices, consumption, and monetary policy: a financial accelerator approach. J Financ Intermed 13:414–435CrossRefGoogle Scholar
  2. Christensen I, Corrigan P, Mendicino C, Nishiyama S-I (2016) Consumption, housing collateral and the canadian business cycle. Can J Econ 49:207–236CrossRefGoogle Scholar
  3. Christiano L, Fitzgerald TJ (2003) The band pass filter. Int Econ Rev 44:435–465CrossRefGoogle Scholar
  4. Christiano L, Eichenbaum M, Evans C (2005) Nominal rigidities and the dynamic effects of a shock to monetary policy. J Polit Econ 113:1–45CrossRefGoogle Scholar
  5. Evans GW, Honkapohja S (1999) Learning dynamics, handbook of macroeconomics, I A, 449–542Google Scholar
  6. Evans GW, Honkapohja S (2009) Learning and macroeconomics. Ann Rev Econ 1:421–449CrossRefGoogle Scholar
  7. Finocchiaro D, Von Heideken VQ (2013) Do central banks react to house prices? J Money Credit Bank 45:1659–1683CrossRefGoogle Scholar
  8. Fukac M, Pagan A (2010) Limited information estimation and evaluation of DSGE models. J Appl Econom 25:55–70CrossRefGoogle Scholar
  9. Funke M, Patz M (2013) Housing prices and the business cycle: an empirical application to hong kong. J Hous Econ 22:62–76CrossRefGoogle Scholar
  10. Galí J, Monacelli T (2005) Monetary policy and exchange rate volatility in a small open economy. Rev Econ Stud 72:707–734CrossRefGoogle Scholar
  11. Greenwood J, Hercowitz Z, Krusell P (1997) Long-run implications of investment-specific technological change. Am Econ Rev 87:342–362Google Scholar
  12. Hahm J. -H., Mishkin FS, Shin HS, Shin K (2011) Macroprudential policies in open emerging economies, Proceedings. San Francisco: Federal Reserve Bank of San Francisco, pp 63–114Google Scholar
  13. Hwang Y (2012) Sources of Housing Price Fluctuations: an analysis using sign-restricted VAR. Korea World Econ 13:249–283Google Scholar
  14. Iacoviello M (2005) House Prices, borrowing constraints and monetary policy in the business cycles. Am Econ Rev 3:739–764CrossRefGoogle Scholar
  15. Iacoviello M, Neri S (2010) Housing market spillovers: evidence from an estimated DSGE model. Am Econ J Macroecon 2:125–164CrossRefGoogle Scholar
  16. Igan D, Kang H (2011) Do loan-to-value and debt-to-income limits work? Evidence from Korea, IMF Working Paper pp 297Google Scholar
  17. Justiniano A, Preston B (2010) Can structural small open-economy models account for the influnece of foreign disturbances? J Int Econ 81:61–74CrossRefGoogle Scholar
  18. Kam T, Lees K, Liu P (2009) Uncovering the hit list for small inflation targeters: a Bayesian structural analysis. J Money Credit Bank 41:583–618CrossRefGoogle Scholar
  19. Kim K-H (2004) Housing and the korean economy. J Hous Econ 13:321–341CrossRefGoogle Scholar
  20. Lee J, Song J (2015) Housing and business cycles in Korea: a multi-sector Bayesian DSGE approach. Econ Model 45:99–108CrossRefGoogle Scholar
  21. Milani F (2007) Expectations, learning and macroeconomic persistence. J Monet Econ 54:2065–2082CrossRefGoogle Scholar
  22. Milani F (2011) Expectation shocks and learning as drivers of the business cycle. Econ J 121:379– 401CrossRefGoogle Scholar
  23. Milani F (2012) The modeling of expectations in empirical DSGE models: a survey. Adv Econ 28:3–38Google Scholar
  24. Milani F (2017) Sentiment and the U.S. business cycle. J Econ Dyn Control 82:289–311CrossRefGoogle Scholar
  25. Milani F, Park SH (2015) The effects of globalization on macroeconomic dynamics in a trade-dependent economy: the case of Korea. Econ Model 48:292–305CrossRefGoogle Scholar
  26. Monacelli T (2005) Monetary policy in a low pass-through environment. J Money Credit Bank 37:1047–1066CrossRefGoogle Scholar
  27. Ng EC, Feng N (2016) Housing market dynamics in a small open economy: do external and news shocks matter? J Int Money Financ 63:64–88CrossRefGoogle Scholar
  28. Preston B (2005) Learning about monetary policy rules when long-horizon expectations matter. Int J Cent Banking 1:81–126Google Scholar
  29. Robinson T, Robson M (2012) Housing and financial frictions in a small open economy, mimeo, Reserve Bank of AustraliaGoogle Scholar
  30. Schmitt-Grohe S, Uribe M (2003) Closing small open economy models. J Int Econ 61:163–185CrossRefGoogle Scholar
  31. Smets F, Wouters R (2007) Shocks and frictions in US business cycles: a Bayesian DSGE approach. Am Econ Rev 97:586–606CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.3151 Social Science Plaza, Department of EconomicsUniversity of CaliforniaIrvineUSA
  2. 2.Bank of KoreaSeoulKorea

Personalised recommendations