Global Excess Liquidity and House Prices - A VAR Analysis for OECD Countries



1 Introduction

The quite expansionary monetary policy of the G3 countries (Euro area, US and
Japan) in combination with foreign exchange interventions by many Asian countries
- especially China with its dollar reserves now standing at 1.5 billion - has during
the last years contributed to a significant increase of global money balances. At
the same time, housing prices in large parts of the OECD have increased in parallel.
Notable exceptions are Japan where house prices stopped their 15-year fall not earlier
than in 2007 and Germany. But it is important to note that house prices generally
seem to move in long-term cycles and the respective time series are much smoother
than stock markets (Goodhart and Hofmann, 2007, Gros, 2007). Moreover, the
increase in the number of mergers and acquisitions and of private equity activities
are discussed in the public joint with global liquidity.

In this paper we will address these issues more deeply and investigate the extent
and some specific macroeconomic impacts of global liquidity. We come up with the
conclusion that the ample liquidity of the Western world has - with an eye on the
current debate about the subprime crisis quite surprisingly - contributed to a lesser
extent to the recent rallye on stock and bond markets than to an increase of house
prices.

Hence, we investigate the existence of a global money market in order to identify
potential excess liquidity and analyse its interactions with global inflation and asset
prices, as suggested by a number of authors, see Baks and Kramer (1999), Sousa
and Zaghini (2006) and Rüffer and Stracca (2006). For this purpose, we estimate
a global VAR model including a measure of global liquidity, proxied by a broad
monetary aggregate in the OECD countries under consideration (United States,
Euro area, Japan, United Kingdom, Canada, Korea, Australia, Switzerland, Sweden,
Norway and Denmark), in order to identify the impact of a shock to excess liquidity
on output and prices at the level of the world economy. In a further step of the
analysis we extend the global VAR model by including a variable measuring house
price developments for the same sample of countries. Our analysis has to take into
account the above-mentioned observation that housing prices generally seem to move



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