Economic Slowdown and Housing Dynamics in China: A Tale of Two Investments by Firms
49 Pages Posted: 13 Mar 2019 Last revised: 4 Apr 2019
Date Written: February 14, 2019
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 are shown to 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 financial 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 monetary and deleveraging policies.
Keywords: Counter-cyclical Housing Boom; Chinese Business Cycles; Collateral Effect; Crowding-out Effect; Stabilization Policies
JEL Classification: E32, E44, E50
Suggested Citation: Suggested Citation