Expectations and Macro-Housing Interactions in a Small Open Economy: Evidence from Korea
- 66 Downloads
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.
KeywordsHousing market-macroeconomy nexus House prices Non-rational expectations Macroprudential policies Household credit Small open economy model Korea’s economy
JEL ClassificationE03 E32 E58 F41 R30
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.
- Evans GW, Honkapohja S (1999) Learning dynamics, handbook of macroeconomics, I A, 449–542Google Scholar
- Greenwood J, Hercowitz Z, Krusell P (1997) Long-run implications of investment-specific technological change. Am Econ Rev 87:342–362Google Scholar
- 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
- Hwang Y (2012) Sources of Housing Price Fluctuations: an analysis using sign-restricted VAR. Korea World Econ 13:249–283Google Scholar
- Igan D, Kang H (2011) Do loan-to-value and debt-to-income limits work? Evidence from Korea, IMF Working Paper pp 297Google Scholar
- Milani F (2012) The modeling of expectations in empirical DSGE models: a survey. Adv Econ 28:3–38Google Scholar
- Preston B (2005) Learning about monetary policy rules when long-horizon expectations matter. Int J Cent Banking 1:81–126Google Scholar
- Robinson T, Robson M (2012) Housing and financial frictions in a small open economy, mimeo, Reserve Bank of AustraliaGoogle Scholar