Expectations and Macro-Housing Interactions in a Small Open Economy: Evidence from Korea

Fabio Milani and Sung Ho Park ()
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Sung Ho Park: Bank of Korea

Open Economies Review, 2019, vol. 30, issue 2, No 7, 375-402

Abstract: Abstract This paper studies the interaction between the housing sector and the macroeconomic environment in Korea. Besides serving as a typical small open economy, Korea provides an interesting laboratory case, since the country was subject to various housing-cycle phases over the sample, and its policymakers implemented active policies to stabilize the housing market. We present a microfounded open-economy model extended to incorporate a housing sector. The model is estimated using Bayesian methods and a large set of observables. We highlight the role of assumptions about house-price expectations on economic dynamics. In the benchmark case of rational expectations, the spillovers from housing to macro variables are modest. House prices are largely driven by sector-specific demand and supply shocks. Business cycle fluctuations are mostly driven by open-economy shocks. When the assumption of rational expectations is relaxed in favor of extrapolative expectations, however, the impact of the housing sector increases. Macroeconomic spillovers from the housing market become more important, with housing shocks accounting for up to twenty percent of fluctuations in the broader economy.

Keywords: Housing market-macroeconomy nexus; House prices; Non-rational expectations; Macroprudential policies; Household credit; Small open economy model; Korea’s economy (search for similar items in EconPapers)
JEL-codes: E03 E32 E58 F41 R30 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s11079-018-9508-x

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