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This paper provides a systematic empirical analysis of the role of the housing market in the macroeconomy in the US and the euro area. First, it establishes some stylised facts concerning key variables in the housing market on the two sides of the Atlantic, such as real house prices, residential investment and mortgage debt. It then presents evidence from Structural Vector Autoregressions (SVAR) by focusing on the effects of monetary policy, credit supply and housing demand shocks on the housing market and the broader economy. The analysis shows that similarities outweigh differences as far as the housing market is concerned. The empirical evidence suggests a stronger role for housing in the transmission of monetary policy shocks in the US. The evidence is less clear-cut for housing demand shocks. Finally, credit supply shocks seem to matter more in the euro area.

The role of the housing market in the business cycle, especially in the US, has been the subject of considerable interest among academics even before, but especially in the wake of, the 2007–2009 financial crisis; for example, the topic of the 2007 Jackson Hole symposium held by the Federal Reserve Bank of Kansas City was the role of the housing market in modern economies (see in particular Mishkin, 2007 and Taylor, 2007). There are several questions that are of much interest for academics and policy-makers, among which three tend to stand out in the debate. First, the role of monetary policy in affecting the behaviour of residential investment and house prices, as opposed to other, possibly non-fundamental, factors that drive house prices up and down, such as bubbles. This role is particularly relevant in the present circumstances as very low nominal and real interest rates in the first half of the decade may have been an important determinant of soaring house prices in the US and elsewhere. Second, the role of the mortgage market in affecting and possibly amplifying the effect of changes in house prices (in turn due to both monetary and non-monetary factors) on consumption, residential investment and overall economic activity through some sort of financial accelerator mechanism. Third, the impact of housing market corrections on financial stability. The role of the housing market in the macroeconomy was particularly prominent in the 2007–2009 financial crisis. Fig. 1 shows that the drop in activity, much more so in the US than in the euro area, was concentrated in residential investment, while consumption slowed down to a much lesser extent both in the US and the euro area. Although there is still controversy about the precise mechanism through which the correction of US housing prices triggered the crisis and the recession, it is clear that the housing market was, this time, the epicentre of the crisis.Shocks that affect house prices and the conditions at which mortgage credit is extended are therefore at the heart of the current policy discussion. Our paper aims to shed some light on the transmission mechanism of housing and mortgage market related shocks on the two sides of the Atlantic. Indeed, although much of this debate concerns the US economy, it is notable that housing prices have also displayed rather strong dynamics on the other side of the Atlantic in the run up to the financial crisis. Fig. 2 reports the behaviour of an index of house prices in the US and the euro area up to 2008. While house prices remained stable in Germany over the last decade, they increased strongly in the rest of the euro area, even more than in the US. In the euro area as a whole, the dynamics of house prices have been similar to the US.In this respect, there are three notable differences between the euro area and the US as far as the housing market is concerned. First, land availability is more abundant in the US than in the euro area, which means that there should be fewer supply constraints in the former.1 The US population is also more culturally homogeneous and therefore mobile, which requires a more liquid and efficient housing market. This is supported by the evidence reported in Fig. 3, showing the number of housing transactions in the US and the euro area, in thousands of units. Second, the mortgage market is more developed in the US and it allows, in particular, a quicker translation of higher (lower) house prices in easier (harder) access to borrowing, notably through Mortgage Equity Withdrawal (MEW) schemes. In the euro area MEW and other mortgage refinancing instruments are relatively underdeveloped, especially in the largest euro-area countries (with the notable exception of the Netherlands). As reported in the latest survey of EU mortgage markets (European Central Bank, 2009), there are even legal restrictions to mortgage securitisation in some EU countries. Looking at a synthetic measure of mortgage market development such as mortgage debt to GDP, the US has always been in the lead compared with the euro area, especially in the last decade. Towards the end of 2008, mortgage debt was about 70% of GDP in the US, and 40% in the euro area (Fig. 4). Differences in the tax and legal systems on the two sides of the Atlantic may largely explain this difference (Ellis, 2010). This observation begs the question of whether the euro area is relatively more sheltered than the US from housing market related shocks. Third, mortgage lending rates are mainly tied to long-term rates in the US, while the situation is more varied in the euro area, where for example mortgage rates are mainly variable in countries such as Spain and Italy. Admittedly, some of these differences in institutional characteristics may be endogenous, but it is plausible that a significant number of them are institutionally-driven and hence to a large extent exogenous. Therefore, by comparing the US and the euro area there is something to be learnt about the role of housing in the business cycle more generally and the importance of institutional factorsAgainst this background, the purpose of the paper is to provide a systematic empirical analysis of the role of the housing market in the macroeconomy in the US and in the euro area. The analysis carried out in this paper is twofold. We first establish some stylised facts concerning key variables in the housing market on the two sides of the Atlantic, such as real house prices, residential investment and mortgage debt. We also look at lead-lag relationships with overall economic activity similar to Leamer (2007). This part of the analysis could be considered as the unconditional one, namely without regard to the structural shocks that are behind the observed developments. We then carry out a structural analysis using a Structural Vector Autoregression approach (SVAR), which is conditional on the identification of a restricted number of structural shocks. The same SVAR model is estimated on US and euro-area data over a sample period from 1986 to 2009 in order to obtain comparable results for the two economies. We first estimate the US and euro-area models separately, and then model US and euro-area variables jointly in order to analyse the international spillovers. The specification and identification of the SVAR is tailored to study the effects of some structural shocks that are of particular interest for studying the nexus between the housing market and the macroeconomy. We focus on monetary policy, (mortgage) credit supply and housing demand shocks and compare the impulse responses in the two economies to understand the similarities and the differences in a systematic manner. 2 One advantage of the SVAR approach is that it allows us to identify the effect of structural shocks while imposing relatively loose identification restrictions that allow the researcher to remain relatively agnostic as to the outcome of the analysis. At the same time, the SVAR cannot be as useful as a fully-fledged dynamic stochastic general equilibrium (DSGE) model in enhancing an understanding of the channels of propagation of shocks. This limitation must be borne in mind in interpreting the results of this paper, as will become evident later on.3 Our paper refers to a small, but burgeoning literature on the effect of including housing and mortgage debt in general equilibrium; see Iacoviello, 2005, Iacoviello and Neri, 2010 and Calza et al., forthcoming. In these papers, the bulk of the effect of changes in house prices on the macroeconomy happens through a collateral mechanism, as credit-constrained households are allowed to borrow only against housing equity. Given that the US and the euro area present, as noted above, important differences as regards the structure of mortgage markets, the comparative analysis that we carry out could convey some important messages for the empirical relevance of the mechanisms that lie at the core of these models. Our paper is also related to previous research showing that residential investment is a leading indicator of, and an important contributor to, the business cycle (Leamer, 2007) and that fluctuations in house prices have significant wealth effects on consumption (Case et al., 2005).4 Overall, our analysis leads to five main results. First, in the descriptive analysis we find many similarities between the US and the euro area as regards key housing market and macroeconomic variables, with one key difference being the cyclical correlation between real house prices and mortgage debt, which is significantly higher in the US, especially on account of a particularly low correlation in Germany. Second, in the SVAR analysis we find more evidence of a role for the housing market in the transmission of monetary policy shocks in the US than in the euro area. Third, concerning housing demand shocks, the evidence is not fully conclusive but still suggests a larger impact of these shocks on consumption in the US. Fourth, we find that negative mortgage credit supply shocks affect housing market variables in the same way as negative housing demand shocks in both the US and the euro area, but overall they are quantitatively much more important in the euro area. Finally, using a two-country SVAR model that includes both US and euro-area variables we find that the effects of domestic shocks on domestic variables are qualitatively similar to those obtained with the closed-economy SVARs. We also find that the cross-border transmission is mainly of the “push” type, and tends to move westwards rather than eastwards, at least based on the variance decomposition analysis. The paper is organised as follows. In Section 2 we present some stylised facts. Section 3 presents the results of the SVAR analysis. Section 4 studies the transmission of shocks across the two economies. Section 5 concludes.

Against this background, the purpose of the paper is to provide a systematic empirical analysis of the role of the housing market in the macroeconomy in the US and in the euro area. The analysis carried out in this paper is twofold. We first establish some stylised facts concerning key variables in the housing market on the two sides of the Atlantic, such as real house prices, residential investment and mortgage debt. We also look at lead-lag relationships with overall economic activity similar to Leamer (2007). This part of the analysis could be considered as the unconditional one, namely without regard to the structural shocks that are behind the observed developments. We then carry out a structural analysis using a Structural Vector Autoregression approach (SVAR), which is conditional on the identification of a restricted number of structural shocks. The same SVAR model is estimated on US and euro-area data over a sample period from 1986 to 2009 in order to obtain comparable results for the two economies. We first estimate the US and euro-area models separately, and then model US and euro-area variables jointly in order to analyse the international spillovers. The specification and identification of the SVAR is tailored to study the effects of some structural shocks that are of particular interest for studying the nexus between the housing market and the macroeconomy. We focus on monetary policy, (mortgage) credit supply and housing demand shocks and compare the impulse responses in the two economies to understand the similarities and the differences in a systematic manner. 2 One advantage of the SVAR approach is that it allows us to identify the effect of structural shocks while imposing relatively loose identification restrictions that allow the researcher to remain relatively agnostic as to the outcome of the analysis. At the same time, the SVAR cannot be as useful as a fully-fledged dynamic stochastic general equilibrium (DSGE) model in enhancing an understanding of the channels of propagation of shocks. This limitation must be borne in mind in interpreting the results of this paper, as will become evident later on.3 Our paper refers to a small, but burgeoning literature on the effect of including housing and mortgage debt in general equilibrium; see Iacoviello, 2005, Iacoviello and Neri, 2010 and Calza et al., forthcoming. In these papers, the bulk of the effect of changes in house prices on the macroeconomy happens through a collateral mechanism, as credit-constrained households are allowed to borrow only against housing equity. Given that the US and the euro area present, as noted above, important differences as regards the structure of mortgage markets, the comparative analysis that we carry out could convey some important messages for the empirical relevance of the mechanisms that lie at the core of these models. Our paper is also related to previous research showing that residential investment is a leading indicator of, and an important contributor to, the business cycle (Leamer, 2007) and that fluctuations in house prices have significant wealth effects on consumption (Case et al., 2005).4 Overall, our analysis leads to five main results. First, in the descriptive analysis we find many similarities between the US and the euro area as regards key housing market and macroeconomic variables, with one key difference being the cyclical correlation between real house prices and mortgage debt, which is significantly higher in the US, especially on account of a particularly low correlation in Germany. Second, in the SVAR analysis we find more evidence of a role for the housing market in the transmission of monetary policy shocks in the US than in the euro area. Third, concerning housing demand shocks, the evidence is not fully conclusive but still suggests a larger impact of these shocks on consumption in the US. Fourth, we find that negative mortgage credit supply shocks affect housing market variables in the same way as negative housing demand shocks in both the US and the euro area, but overall they are quantitatively much more important in the euro area. Finally, using a two-country SVAR model that includes both US and euro-area variables we find that the effects of domestic shocks on domestic variables are qualitatively similar to those obtained with the closed-economy SVARs. We also find that the cross-border transmission is mainly of the “push” type, and tends to move westwards rather than eastwards, at least based on the variance decomposition analysis. The paper is organised as follows. In Section 2 we present some stylised facts. Section 3 presents the results of the SVAR analysis. Section 4 studies the transmission of shocks across the two economies. Section 5 concludes.