The Role of the Federal Reserve in the U.S. Housing Crisis: A VAR Analysis with Endogenous Structural Breaks

Abstract

This paper reexamines the role of the Federal Reserve in triggering the recent housing crisis. Specifically, we explore if the relationship between the federal funds rate and the housing variables underwent structural changes in the wake of the housing crisis. Using quarterly data spanning 1960–2017, we estimate a VAR model involving federal funds rate, real GDP growth and a housing variable (captured by house price inflation or residential investment share or housing starts) and conduct time series analysis for the pre- and post-crisis periods. While previous studies mostly set break-dates based on events known a priori to split the full sample to subsamples, we endogenously determine structural break points occurring at multiple unknown dates. Our Granger causality analysis indicates that the federal funds rate did not cause house price inflation, although it caused residential investment share and housing starts in the pre-crisis period. In the post-crisis period, the real GDP growth caused residential investment and housing starts while house price inflation had a momentum of its own. Our impulse response and forecast error variance decomposition analysis reinforce these results. Overall, our findings suggest that housing volume fluctuates more than house prices over the business cycle.