Residential investment and economic activity: evidence from the past five decades

Summary

Focus

The paper studies the evolution and key drivers of residential investment in 15 advanced economies since the 1970s. It also analyses how residential investment growth affects overall economic activity and the likelihood of recessions.

Contribution

Most previous research on housing markets has focused on house prices, whereas research on housing quantities - ie residential investment - has been scarce. There has also been little cross-country analysis of the determinants of residential investment. This paper partly fills this gap. It studies the key drivers of residential investment across countries and the impact of residential investment on the broader economy. We provide novel evidence on the effects of monetary policy on the residential investment cycle, highlighting the asymmetric effects of rising and falling interest rates.

Findings

We find that the key drivers of residential investment in advanced economies are house price growth, net migration, the size of the housing stock and nominal interest rates. Importantly, rising interest rates have stronger effects on residential investment than falling ones. This could result from downward rigidity in house prices, which forces housing construction rather than prices to fall as interest rates rise. We also show that declines in residential investment are a good predictor of economic recessions.

Abstract

We analyse the evolution and main drivers of residential investment, using a panel with quarterly data for 15 advanced economies since the 1970s. Residential investment is a notably volatile component of real GDP in all countries in the sample. We find real house price growth, net migration inflows and the size of the existing housing stock to be significant drivers of residential investment across various model specifications. We also detect important asymmetries: interest rate increases affect residential investment more than interest rate cuts, and interest rate changes have larger effects on residential investment when its share in overall GDP is rising. Finally, we show that adding information on residential investment significantly improves the performance of standard recession prediction models.

JEL classification: E22, E32, E37, E43, E52, F44

Keywords: housing markets, residential investment, house prices, business cycles, construction, interest rates, recession forecasts