Working Paper Series no. 275: Common business and housing market cycles in the Euro area from a multivariate decomposition

Abstract

The 2007 sub-prime crisis in the United States, prolonged by a severe economic recession spread over many countries around the world, has led many economic researchers to focus on the recent fluctuations in housing prices and their relationships with macroeconomics and monetary policies. The existence of common housing cycles among the countries of the euro zone could lead the European Central Bank to integrate more specifically the evolution of such asset prices in its assessment. In this paper, we implement a multivariate unobserved component model on housing market variables in order to assess the common euro area housing cycle and to evaluate its relationship with the economic cycle. Among the general class of multivariate unobserved component models, we implement the band-pass filter based on the trend plus cycle decomposition model and we allow the existence of two cycles of different periods. The dataset consists of gross domestic product and real house prices series for four main euro area countries (Germany, France, Italy and Spain). Empirical results show a strong relationship for business cycles in France, Italy and Spain. Moreover, French and Spanish house prices cycles appear to be strongly related, while the German one possesses its own dynamics. Finally, we find that GDP and house prices cycles are related in the medium-term for fluctuations between 4 and 8 years, while the housing market contributes to the long-term economic growth only in Spain and Germany.

Laurent Ferrara and Siem Jan Koopman
January 2010

Classification JEL : C13, C32, E32, R21

Keywords : House prices, Business cycles, Euro area, Unobserved components model.