Icelandic boom and bust - Immigration and the housing market

Lúðvík Elíasson

Economics from Department of Economics, Central bank of Iceland

Abstract: Possible explanations for the rapid increase in house prices and housing investment in Iceland between 2004 and 2007 and the subsequent market crash are studied. The boom was driven in part by banking liberalisation, international financial conditions, and domestic policies. A simple demand and supply model, based on the study by Elíasson and Pétursson (2009), is fitted to data through the recent boom-bust period. The model is remarkably robust through the cycle despite its unprecedented amplitude. However, it does not capture fully the turbulence in housing market data for the period since 2003. Different methods to account for the rapid rise in house prices and housing investment dynamics are compared. The price equation (demand) is improved by including net immigration as an explanatory variable showing that demographic factors, in addition to mortgage market restructuring, help in explaining the apparent bubble in the housing market. The sharp fall in housing investment in 2009 cannot, however, be modelled without the introduction of a dummy variable, accounting for the sudden-stop in financing at the beginning of the financial crisis in Iceland in late 2008.

Date: 2014-11
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