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Earlier Intervention Policy is Best for Housing Boom/Bust Cycles

by devteam May 5th, 2015 | Share

After looking at housing booms and busts in 20 countries,rnthree economists have concluded that the likelihood of a boom ended in arnhousing market cycle depends on its age – that is that the longer the cyclerncontinues, the probability that it will end increases (positive durationrndependence).  They did not find the samernwas true of housing busts.</p

The three, Luca Agnello of the University of Palermo, VitorrnCastro, University of Coimbra (Portugal), and Ricardo M.Sousa University ofrnMinho, (Portugal) and London School of Economic, were prompted to do theirrnstudy by the prolonged housing bubble following the dot-com bust in the early 2000srnfollowed by the recent housing crisis.</p

Their article, Booms, Busts, and Normal Times in thernHousing Market, notes thatrnagainst the background of the subprime boom, and subsequent Great Recession andrnlong and persistent slump in the housing market, it became a policymakingrnpriority to investigate the determinants of this boom-bust behavior.</p

Research done in 2011 and 2013 indicated that while housingrnbusts showed no evidence of positive duration experience it did seems thatrnthere was lagged duration dependence – that is housing downturns are lessrnlikely to end when the preceding upturn was abnormally long.</p

The research, published in the American Statistical Association Journal ofrnBusiness and Economic Statistics, sought to answer these questions:</p<ul class="unIndentedList"<liHow long are housing booms, business and normalrntimes likely to last?</li<liHow similar or different are these phases in Europeanrnand non-European countries?</li<liDoes the end of a boom or bust depend on its ownrnage?</li<liIs the duration of each cycle smooth or bumpy?</li<liHas the duration of market cycles changed overrntime?</li</ul

Thernauthors first identified the various stages of housing market cycles then lookedrnat data for 20 industrialized countries spanning a period from the firstrnquarter of 1970 to the second quarter of 2012, and constructing a continuousrntime Weibull model.  They found that thernlikelihood of both booms and busts and to some extent normal cycles coming tornan end increases over time and that each tends to be longer than the previousrnphase of the cycle, no matter its type. rnThey also found that the duration of the different stages of the housingrnmarkets has increased over recent decades.</p

Lookingrnat differences between European and non-European countries including the U.S.rnthey found housing booms to be broadly similar in terms of length but the bustsrnto be shorter in European countries. rnThere was also a positive duration dependence in booms of both Europeanrnand non-European countries but housing busts in non-European countries do notrnseem to be duration dependent.  </p

Theyrnalso corroborated the existence of time-varying duration dependence for boomsrnand busts.  “In particular, we find thernhousing boom and busts that last less than 26 quarters display (positive)rnduration dependence, but the same does not hold for older events.”  When booms or busts) have a duration shorterrnthan 26 quarters each additional quarter on average increases the likelihood ofrnthe end of the stage by 4.01percentage points in booms and 7.01 percentage pointsrnin busts.  In contrast, in those longerrnthan 26 quarters each additional quarter raises the likelihood of their end byrnonly 1.76 (boom) and 3.68 (bust) percentage points.  </p

The authors say that from a policy perspective the studyrnprovides information that can be useful for predicting the timing and length ofrnboom-bust cycles and thus in designing and implementing stabilizingrnpolicies.  Moreover, by looking at thernstages of housing cycles across groups of countries it contributes to a betterrnunderstanding of the degree of synchronization of housing prices globally.</p

While they stress they cannot draw predictions and policyrnimplications for specific countries their key finding is that, while relativelyrnshort-lived housing booms tend to deflate, more prolonged booms are likely tornspiral out of control and longer term busts when compared to shorter ones arernmore likely to turn into chronic slumps and lead to severe recessions.</p

The authors conclude that the time-varying nature of housingrncycles provides a rational for preventive policy interventions during booms andrnbusts.  “In particular given that thernduration of housing boom and housing bust episodes is conditional on their ownrnage, a timely policy response to such events is crucial to keep them underrncontrol.”  They say that a counter-cyclicalrnpolicy intervention that takes place before that 26 quarter mark is key tornsmoothing out large and persistent price swings and speeding up the return to arnnormal phase.  When booms and busts getrntoo long, the likelihood of their end increases by only half when compared tornshorter events making it more difficult to circumvent such episodes withoutrnavoiding financial distress and crisis management.  “For this reason, a ‘wait-and-see’ strategyrnis not recommended for housing booms and housing busts lasting less than 26rnquarters”

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About the Author

devteam

Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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