Inflation and House Prices: Theory and Evidence from 35 Major Cities in China

Abstract

In recent years, housing prices and inflation have been growing constantly in China. Higher house prices and higher inflation affect both household consumption and economic growth. We have developed a four-sector general equilibrium model of consumers, developers, firms, and the central bank to illustrate the relationship of house prices with inflation. The theoretical model demonstrates that house prices and inflation are positively correlated and endogenously determined. By using panel databases of 35 major cities in China during the period of 1996-2010, we find that the association between house prices and inflation is asymmetric. The impact of inflation on housing prices is greater than that of housing prices on inflation, which implies that housing prices effectively hedge inflation. Secondly, household income positively affects housing prices, but interest rates negatively influence housing prices. Accordingly, to curb soaring housing prices, policymakers not only should balance supply and demand, but also control for inflation. Thirdly, economic growth has less of an impact on inflation than housing prices. Hence, abnormal housing price increases are more likely to exacerbate inflation than economic growth. In addition, housing prices have a greater impact on inflation than rental prices, albeit the latter is a component of the consumer price index (CPI). Finally, money supply has much greater effects on inflation than housing prices and economic growth.
 

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Keywords

Housing Price, Inflation, Endogeneity Issue

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