Housing Price Hikes Caused by Real Effective Exchange Rate Changes

When governments print more and more money, people are looking for inflation hedging investment opportunities globally. Real estate is well known to be a good inflation hedge, and especially after the Global Financial Crisis 2008, investors are buying houses in mega-cities. There are at least two ways to test whether foreign buyers are causing housing price hikes, the first approach is to test the relationship between capital inflows and housing prices, and the second one is to test the relationship between real effective exchange rate (REER) and housing prices.

There have been many studies on the former approach and confirmed the positive relationship, for example, Sá et al. (2011) found that capital inflows have a significant and positive effect on real house prices in OECD countries.

Yiu et al. (2013) also posited that “it is natural to ask that, if capital inflows are the driving factor of the housing bubble”, and they contended that “because of its bounded territory, Hong Kong, as well as Singapore, is relative easier to face housing bubbles due to the expectation of limited supply of housing”, thus global investors would be attracted into these markets.

This article, however, tries to review the studies adopting the REER approach. The hypothesis is that when real exchange rate depreciates, housing price becomes more attractive to foreigners, higher demand of housing by foreign buyers would result in higher housing price.

Asal (2019) argues “that another important determinant of housing demand and prices is the real effective exchange rate. In standard small open economy models in which foreign investment plays an important role, such as in Sweden, real exchange rate depreciation (i.e. an improvement in international competitiveness) has an expansionary effect on aggregate demand, improves the current account position and can drive up housing prices.”

Asal (2019) found the following four main factors driving housing prices:

Lower interest rates, relaxed lending standards, sluggish rents and weak currency, among other factors, are likely to be important drivers of Swedish housing prices in recent years.”

Empirically he found that “foreign ownership of vacation homes in Sweden amounted to 6.5 percent of the vacation housing stock in the country. … A 1 percent increase in the real effective exchange rate (e.g. deterioration of Swedish competitiveness) leads to a 1.7 percent decrease in real house prices.”

Graphically, Figure 13 shows that except for the 2003–2004 and 2012–2013 periods, both series of REER and Real Housing Price (RHP) move together throughout the sample period after filtered by HP Filter.

Figure 1 Times Series of REER and RHP. Asal (2019)

However, the use of REER to test the effect of foreign investment on housing price can be problematic. First, the weakening of the exchange rate may be due to weak economic prospects. Thus, instead of attracting more foreign capital inflows, a net capital outflow may happen at the same time when the exchange rate depreciates.

Second, even if the exchange rate is depreciated, foreign investors may not invest in the country due to many other institutional and economic factors.


Asal, Maher (2019) Is there a bubble in the Swedish housing market?, Journal of European Real Estate Research, 12(1), 32–61, https://doi.org/10.1108/JERER-03-2018-0013

Sa, Filipa G., Towbin, Pascal and Wieladek, Tomasz, (2011) Low Interest Rates and Housing Booms: The Role of Capital Inflows, Monetary Policy and Financial Innovation (February 21, 2011). Bank of England Working Paper №411. Available at SSRN: https://ssrn.com/abstract=1765853 or http://dx.doi.org/10.2139/ssrn.1765853

Yiu, M.S., Yu, J. and Jin, L. (2013) Detecting bubbles in Hong Kong residential property market, Journal of Asian Economics, 28, 115–124.

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