Economic Slowdown and Housing Dynamics in China: A Tale of Two Investments by Firms

47 Pages Posted: 13 Mar 2019 Last revised: 6 Jun 2021

See all articles by Feng Dong

Feng Dong

Tsinghua University - School of Economics and Management

Yumei Guo

Central University of Finance and Economics (CUFE) - School of Finance

Yuchao Peng

Central University of Finance and Economics (CUFE) - School of Finance

Zhiwei Xu

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management

Date Written: February 14, 2019

Abstract

In the past decade, the Chinese economy has witnessed a great housing boom, accompanied by a slowdown in economic growth and an increase in firms' financial investment. The waning economic prospects lead to a surge in housing prices by stimulating firms' demand for financial (especially housing) assets. Motivated by these facts, we take an off-the-shelf dynamic New Keynesian model with novel modeling of firms' dynamic portfolio choice between physical and housing investment. Housing assets earn a positive return and can be used as collateral for the firm's external finances. A negative productivity shock decreases the relative return of production capital, which translates into a housing boom by increasing the firm's housing demand. A rise in house prices then generates competing effects on real investment: it not only raises the firm's leverage due to the collateral effect but also depresses the firm's demand for physical capital because of the crowding-out effect. After calibrating the model for the Chinese economy, our quantitative exercise suggests the former effect is dominated by the latter, which implies counter-cyclical housing prices. Among the policies used to stabilize the aggregate economy and housing markets, our counterfactual analysis implies that the capital subsidization policy targeting house prices performs better than other macroeconomic policies.

Keywords: Counter-cyclical Housing Boom; Chinese Business Cycles; Collateral Effect; Crowding-out Effect; Stabilization Policies

JEL Classification: E32, E44, E50

Suggested Citation

Dong, Feng and Guo, Yumei and Peng, Yuchao and Xu, Zhiwei, Economic Slowdown and Housing Dynamics in China: A Tale of Two Investments by Firms (February 14, 2019). Available at SSRN: https://ssrn.com/abstract=3334337 or http://dx.doi.org/10.2139/ssrn.3334337

Feng Dong

Tsinghua University - School of Economics and Management ( email )

School of Economics and Management
Tsinghua University
Beijing, Beijing 100084
China

HOME PAGE: http://fengdongecon.weebly.com

Yumei Guo

Central University of Finance and Economics (CUFE) - School of Finance ( email )

Beijing
China

Yuchao Peng

Central University of Finance and Economics (CUFE) - School of Finance ( email )

Beijing
China

Zhiwei Xu (Contact Author)

Shanghai Jiao Tong University (SJTU) - Antai College of Economics and Management ( email )

No.535 Fahuazhen Road
Shanghai Jiao Tong University
Shanghai, Shanghai 200052
China

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