L ITERATURE R EVIEW

2.1.1 The Relation between House prices and Economics

Looking back at the role of the real estate market in economic development, one could find that housing was considered the social spending during the post-war period from 1945 to 1960, when houses were consumer goods and had no direct productivity to consumers.

Investment in housing did not fit the bill. The house building industry relied on hand-powered technology, used limited capital, and was characterised by low wages and productivity. Worse, housing itself was seen as a consumer good which had a limited and indirect effect on the productivity of its consumers. As Strassman(1970) observed, from this point of view

‘‘financing housing without raising productivity was throwing money into a bottomless pit.’’

Indeed, such investment could appear to be the very worst type of consumer spending since it tied up capital for such long periods of time.

During 1950-1960s, those development economists who considered the economic significance of housing found it impossible to dismiss the subject entirely, residential investment were already deemed to be helpful to economic growth. In addition to many industrial activities driven by the construction industry, economic growth was further influenced by its impact on employment, savings, investment and labor productivity (Turin, 1969; Liu et al., 2004; Dlamini, 2012; Chang et al. 2013). During 1960-2000s, the economic development driven by the construction industry made the real estate begin to be considered a

type of investment products (Harris and Arku, 2006). According to international references regarding real estate and economic growth, three outlooks on the real estate market had different degree of influence in economic growth under different backgrounds and national policies. First: the real estate was simply a type of consumer products; second: the real estate was the locomotive of economy, which brought activities and drove economic growth; third:

the real estate generated wealth and transferred into a type of investment products. Three viewpoints have always co-existed, while the balance among them has shifted.

Dlamini (2012) indicated that Construction is a major industry throughout the world accounting for a sizeable proportion of most countries’ Gross Domestic Product (GDP), using time series statistical analysis of construction share of GDP for South Africa. Found that there is evidence of the existence of a very strong relationship between construction activity and economic growth. As an investment sector, construction has the potential to impact positively on short-run growth. Construction can thus be regarded as a major component of investment, particularly for developing economies like South Africa. But the trend could not be sustainable for continuous economic growth, the sharp decline in construction share of GDP from 15% in 2007 to 1.5% in 2010. Considering the fundamental significance of the construction sector in employment creation, capital formation and its aggregate spillover effects, it is clearly an important sector in the economy.

Turin (1969) showed that the developed national construction industries during 1955-1965 accounted for 5-8% of GDP, and for developing national construction industries accounted for 3-5% of GDP. Consider construction industry for the development of the country plays a very important role, can create a lot of employment opportunities and labor productivity through construction. Furthermore, Wells (1985) pointed out that when a country’s GDP rises, the construction industry to GDP ratio will rise, and the rising speed of proportion will increase as income increase.

The study of Liu et al. (2004) using Granger causality analysis, this paper examines the

interaction between housing investment and economic growth as well as that between non-housing investment and economic growth, showed that residential investment had stronger short-term effect on economic growth than non-residential investment, and residential investment had a long-term effect on economic growth, while economic growth has a log run effect on both housing and non-housing investment. Suggest that housing investment is an important factor for the short-term fluctuations of economic growth. Chang et al. (2013) also use Granger causality analysis the causal relationship between housing activity and growth in nine provinces of South Africa for the period 1995-2011, found that nine of the seven provinces has significant relation between house prices and economic, but changes of GDP is not significant to house prices. Furthermore, Lin et al. (1996) use the method of composite index of business cycle for real estate cycle indicators, reveals the macro-variables, such as GDP, M2, the index of stock market, CPI ect., tend to be leading indicators of real estate activities over twelve months approximately. Means the macro-variables can forecast the trend of real estate cycle in the future.

According to references regarding real estate and economic growth, the real estate market had different degree of influence in economic growth under different backgrounds and national policies. Based on the background above, in recent years many countries have experienced issues of real estate bubbles and economic growing slow generated under quantitative easing policy. The study aimed to explore whether house prices had wealth effects and positive influences on economic growth in Taiwan under the quantitative easing background.

2.1.2 The relation between House Prices and Consumption

There are many references regarding relevant study on house prices and consumption, research indicates that house prices may affect consumption patterns through the following:

1. Realized or unrealized of wealth effect:

When the house price increased, owners realized the capital gains from real estate

through acts of sale, which further influenced consumer spending of residents. The increase of house prices added owners’ wealth of real estate; although residents did not cash increased wealth through withdrawing capital gains, their expectations made them think that they were more wealthier than before and increased consumer spending in the current period; Cooper (2010), for example, using data from the Panel Study of Income Dynamics, show that during the height of the house-price boom (the 2003–2005 period) a one-dollar increase in equity extraction led to 14 cents higher household expenditures. Households also spent 21 cents of their extracted equity on home improvements and additions and saved roughly 19 cents of each dollar extracted through balance-sheet reshuffling; indicated that house prices could generate realized or unrealized wealth effects. However, Buiter (2010) represent agent model and in the Yaari-Blanchard OLG model, found that there is no pure wealth effect on consumption from a change in house prices if this represents a change in fundamental value, while the changes of house prices were measured by speculation and bubbles, they could bring wealth effect to consumption. And a decline in house prices reduces the scope for mortgage equity withdrawal. For given sequences of future after-tax labor income and interest rates, this may depress consumption in the short run while boosting it in the long run.

2. Real estate mortgage or liquidity constraints affect:

Over the past ten years, many homeowners have taken advantage of lower mortgage interest rates and higher home values and have refinanced their mortgage loans. After the house price increased, households would relieve their liquidity constraints by way of residential mortgage, which will further benefited the increase of consumption. Glenn et al.

(2006), for example, studied US household refinancing behavior between 1983-2001.

Refinancers taking cash out spent 35 percent of liquefied equity on home improvements and used 26 percent to pay off other debt. They used 16 percent of the funds for consumer expenditures, 10 percent for real estate or business investments, 11 percent for stock market

investments, and 2 percent for taxes. Pointed out that part of refinancing is reason for consumption. As well as Haurin and Rosenthal (2006), find that for each dollar of house price appreciation, households take on roughly 15 cents additional debt, and use to finance consumer expenditures. The debt response to house price appreciation generally increases with age and income, but is markedly lower among individuals over age 65. Homeowners save most of their housing capital gains and also helped to prop up consumer spending. Mian and Sufi (2009), employing land topology-based housing supply elasticity as an instrument for house price growth, estimate that the average homeowner extracts 25 to 30 cents for every dollar increase in consumption or home equity.

3. The influence of budget constraints on tenant:

The increase of house prices would increase the housing cost of tenants, under the condition of unchanged income, will decreased the non-residential consumer spending of tenants. Li and Yao (2007), pointed out that house prices in the U.S. had an influence of budget constraints on tenants, which influenced consumption. House prices should bring different wealth effect to different consumer groups. Based on different ages and statuses of homeowners, each 11.5% increase of house price would bring the 2% real wealth effect to homeowners who aged more than 65. For young homeowners between late 20s to mid 30s face a long horizon of future housing consumption, and on average, are expecting to move up in the housing ladder. Thus, their investment gains from existing housing positions are not sufficient to compensate them for the increase in their lifetime housing consumption costs. So a positive housing shock incurs about a 2 percent utility loss for young homeowners. Observe renters' welfare since they have to bear the higher cost of acquiring lifetime housing services without receiving any housing wealth gains. A positive house price shock of 11.5 percent leads to a welfare loss of around 4.5 percent. Overall, the increase of house prices only improved the wealth effect of old homeowners, but had a negative influence on tenants and young homeowners.

4. The influence of the purchase new homes:

While house prices rising the payment of principal and interest also increase, in order to purchase house, the young people or tenants have to increase savings resulting consumption decreased. In addition, some studies indicate house prices change will not necessarily impact on consumption. Attanasio et al. (2009), for example, indicated that the wealth and collateral channels are important for some households at some points in time. But, on average over the past 25 years, pointed out that wealth of real estate and mortgage constraints were not the main reasons that influenced consumer spending.

As a result, references conflicted with each other, and most of references were relevant research conducted before the implementation of easing monetary policy. The study aimed to explore the impact of changes in house prices on consumption in Taiwan under the quantitative easing background. To study whether house prices had wealth effects and positive influences on consumer spending, and further promoted economic growth.