Expectations-driven cycles in the housing market

Abstract

This paper explores the transmission of “news shocks” in a model of the housing market and shows that anticipated signals or beliefs of future macroeconomic developments can generate boom-bust cycles in the housing market and lead to business cycle fluctuations. Anticipated monetary policy and inflationary shocks that turn out to be wrong can also lead to subsequent macroeconomic recessions. Credit frictions also play an important role in generating boom-bust cycle dynamics in the housing market. In particular, favorable credit conditions that are expected to be reversed in the near future generate an housing boom. The active use of the loan-to-value ratio as a policy tool aimed at dampening the severity of expectations-driven cycles effectively reduces the volatility of household debt, aggregate consumption and GDP.