New Econometric Models for South African House Prices, Mortgage Debt and Residential Investment

Abstract:

Housing markets and the associated credit markets have important implications for monetary transmission, stabilisation policy and for financial stability. The crucial role of housing wealth as collateral for mortgage borrowing in South Africa, means that changes in housing wealth, mainly due to house price changes, induce large effects on consumer spending. Moreover, residential investment, also driven by house prices, is a volatile component of aggregate demand. It is important therefore to understand the dynamics of house prices, and how they feed through to consumption, mortgage debt and residential investment. This paper develops econometric models for house prices, the mortgage stock and residential investment in South Africa, drawing on insights from theory and the findings of the international literature, and complementing our previous research on consumption (Aron and Muellbauer, 2013). These equations are suitable for incorporation in the SARB’s Core Model, improving on the existing house price and mortgage stock equations and clarifying the residential investment channel, currently modelled only through aggregate investment. The estimated equations yield important insights into monetary transmission, with a powerful transmission from interest rates and credit conditions in the mortgage market to house prices, and hence into aggregate demand. There is evidence of a memory of up to four years regarding the expectations of house price appreciation by housing market participants. This implies that a series of positive shocks to housing demand can feed back positively onto housing demand and onto house prices, so extending boom conditions. This can potentially cause house prices to overshoot relative to their fundamentals, with clear implications for risks to financial stability. These new findings should benefit future development of the SARB’s Core policy model of the economy to better inform policy makers.