Current Account Imbalances, House Prices, and Institution

Abstract

Current account imbalances and housing price boom-bust cycles have become the defining characteristics of the pre-global financial crisis period. In the same period, it is observed that even though the developments of the economies show similar trends in many countries (e.g. an increase in credit supply, a decrease in interest rates), they have distinct characteristics (e.g. the volatility of house prices, and level of current account imbalances). Additionally, their final impacts on the economy vary to a significant degree from country to country. The institutional features of the markets (e.g. accessibility of credit information, protection of investors) have the potential to contribute to this differentiation. However, there are no studies on the effect of institutional features on the relationship between house prices and current account imbalances. The aim of this study is to examine the relationship between house prices and current account imbalances as well as the role of institutions in this relationship for 14 EU countries. To do so, a simultaneous equations model is used. The results of the empirical analysis show that in the 2007-2008 global financial crisis, there is a positive and significant relationship between house prices and current account imbalances, and institutional features have a potential role in the strength of this relationship.

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