Housing and Commodity Investment Booms in a Small Open Economy

Abstract

We add a housing sector to the Reserve Bank of Australia's small open-economy model to explore the effect of commodity price shocks on housing investment. The model predicts that housing investment booms may follow commodity booms. Commodity booms have a persistent effect on housing services price inflation and they 'crowd out' housing investment. When the commodity boom ends, the combination of higher prices and falling interest rates induces a significant housing investment response. The model attributes a significant share of the recent increase in housing investment in Australia directly to falling commodity prices.

Inflation Expectations in Australia

“…Like the models discussed above, the RBA's macroeconometric model (MARTIN) incorporates both trend and adaptive expectations into its price and wage inflation equations (Ballantyne et al 2019). Whereas the RBA's DSGE model assumes expectations are ‘rational’ (i.e., all available information about the economic shock and its dynamics are immediately incorporated into expectations), which means that expectations are constructed as part of the model solution such that the model does not require any external measures of expectations (Rees, Smith and Hall 2015; Gibbs, Hambur and Nodari 2018). 3…”

Assessing Australian Monetary Policy in the Twenty-First Century

“…Hall and Smith (2016), henceforth RHS. 14 RHS is a large scale, small open economy model 14 We also considered an extension of this model that includes a housing sector as outlined by Gibbs, Hambur, and Nodari (2021). However, the estimated flexible-price output gap was so implausible as to render the results of the exercise nonsensical.…”

House Prices, Monetary Policy and Commodities: Evidence from Australia*

“…In recent work, Gibbs et al . (2021) study a small open‐economy Bayesian dynamic stochastic general equilibrium (DSGE) model estimated with Australian data to analyse the effects of commodity price shocks on housing investment and prices. The model predicts a commodity price boom crowds out housing investment as investment funds are directed towards commodity‐producing industries.…”