are essential for our model and otherwise an omitted variable bias might occur.
Alternatively, one could argue that house prices and inflation expectations might
be correlated, since the lack of an inflation expectation variable is often supposed
to be the reason for the existence of the ”price puzzle”. The liquidity shock impact
on the price level is slightly lower than in the basic model. However, by adding up
both effects that may represent (recent) expansionary monetary policy (money and
interest rate shock), we assess substantial upward pressures on inflation, while, once
again, the long time lags of these effects have to be taken into account.
The responses of the house price index to the interest rate and to liquidity
are significant over quite a long period. Both graphs support our view that loose
monetary policy and ample global liquidity have contributed to the hausse in the
real estate sector which is in line with our theoretical considerations. Analysing a
house price shock, which may be especially relevant in the present situation, gives
some additional insights. A house price shock raises liquidity which may not least be
due to rising credit demand. This evidence is not surprising given the cointegration
relationship between money and house prices found by Greiber and Setzer (2007)
for the Euro area and the US, and renders further support to the assumption that
housing should be considered in money demand models. More surprisingly, a house
price shock causes a rise in interest rates (row 3, column 3). Since it has not been
commonly known until now that monetary policy makers are reacting directly to
house price developments,16 this raises again the question to what degree house
prices are linked with inflation expectations or forecasts, respectively.
Table 2 displays the forecast error variance decomposition for the house price
index and the price level. Over the long term (forecasting 16 quarters), the monetary
variables (money and the interest rate) are responsible for nearly half of the volatility
in the housing sector. This confirms the results of the impulse response analysis
that both liquidity and interest rates are important determinants for pricing in
the real estate sector. House prices themselves are causing a great percentage of
price level forecast volatility, namely over 40% after 16 quarters. In combination
with the corresponding impulse responses, this supports the existence of spill-overs
16 For now, the subprime crisis ought to contribute to a changing behaviour in this respect.
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