Self-reinforcing effects between housing prices and credit

• We find a mutual dependence between housing prices and credit in Norway.
• The short run dynamics is modeled using a procedure of structural model design.
• Households’ expectations about future economic developments affect housing prices.
• Dynamic simulations give evidence of a financial accelerator in the housing market.
• When we include a model for housing supply, the responses to shocks are dampened.

The financial crisis has brought the interaction between housing prices and household borrowing into the limelight of the economic policy debate. This paper examines the nexus of housing prices and credit in Norway within a structural vector equilibrium correction model (SVECM) over the period 1986q2–2008q4. The results establish a two way interaction in the long-run, so that higher housing prices lead to a credit expansion, which in turn puts an upward pressure on prices. Interest rates influence housing prices indirectly through the credit channel. Furthermore, households’ expectations about the future development of their own income as well as in the Norwegian economy have a significant impact on housing price growth. Dynamic simulations show how shocks are propagated and amplified. When we augment the model to include the supply side of the housing market, these effects are dampened.