How house prices in markets around the world are affected by changes in global liquidity
Can government policy measures help protect housing markets from liquidity shocks?
Although there is no absolute agreed definition of the term 'global liquidity', it is widely thought of as the availability of funds, and the ease of financing, in global financial markets. It is the liquidity that crosses borders, and affects (directly or indirectly) the credit conditions in recipient countries. It is the focus of much academic inquiry.
The paper Global liquidity, house prices and policy responses investigates the impact of global liquidity on house prices around the world, and the effectiveness of government policies to counter this exposure.
The research focuses on the period from 2000 to 2014. In the years from 2000 to 2008, benign funding conditions in the major financial systems encouraged an increase in cross-border bank flows, and house prices around the world enjoyed a sustained rise. Then, in 2008 the Global Financial Crisis (GFC) wreaked havoc in financial systems and brought about severe shortages in global liquidity.
The fallout from the GFC hit both house prices and bank flows hard, as key financial markets experienced severe liquidity dry-ups and credit conditions worsened around the world.
The response of monetary authorities to the subsequent economic downturn unleashed un-precedented amounts of liquidity. As the financial crisis eased, house prices resumed their upward trend.
Countries have responded to these evolving cycles by developing policy frameworks, such as a variety of macroprudential policies, to tackle potential threats to financial stability and economic growth.
This paper investigates the effectiveness of these policies in tackling and mitigating the exposure of housing markets around the world to global liquidity. It asks whether countries that use macroprudential policy to restrain the local banking sector and housing market are able to effectively shield economies from changes in global liquidity. To offer a comprehensive analysis of policy responses, the study considers the effectiveness of monetary policy and capital controls as well.
Although the study finds that global liquidity does impact house prices, the question arises whether its effect is sufficiently large to elude macroprudential policy measures and weaken the effectiveness of domestic monetary policy.
The research shows that domestic governments can use monetary policy, in the form of interest rate changes, to mitigate the impact of global liquidity on house prices in advanced and emerging markets. Importantly, using an interactive panel vector autoregression model (PVAR) it finds that the adoption of macroprudential policy frameworks can reduce a country’s exposure to global shocks. This is especially evident in advanced economies.
In emerging markets, it's found that banking and some housing macroprudential policy measures mitigate but do not offset the effects of global shocks. Nonetheless, analysis shows that emerging markets can successfully rely on restrictions to non-resident investments in the local real estate sector to shield their house prices from liquidity shocks.
These findings have policy implications for countries which would like to limit their exposure to global liquidity.
This research has been published in Journal of Financial Stability. The accepted version of the paper is available for download at City Research Online.