Lending Policy Determines Housing Price or Housing Price Determines Lending Policy?

There have been many studies confirming that real interest rate is strongly and negatively correlated with housing prices, not only in Hong Kong but also in many other cities. (Yiu, 2009) However, since the lending rate in Hong Kong is determined by the US due to the link exchange rate, it is reasonable to argue that lending rate determines housing price in Hong Kong. Yet, the loan-to-value ratio and other lending policy are normally a response to housing price changes, would housing price determines lending policy?

A recent book written by Josh Ryan-Collins (2018) titled ‘Why can’t you afford a home?’ provides a ‘self-reinforcing feedback cycle’ theory about the impacts of lending policy, including lending rate, on housing prices:

‘In order to afford a home, most people need a mortgage. But when mortgage credit is extended to buy an existing property, it inflates house prices as bank lending involves the creation of new money. If house prices rise faster than incomes, the demand for mortgages increase, banks lend more, prices go up and so on’. (Ryan-Collins, 2018)

Another recent study of housing price in China also confirms that ‘to cool overheated housing prices in China, controlling [real] lending rates is more effective than controlling the lending supply as a long-term measure.’ (Jiang et al., 2018)

Figure 1 Nation-level Granger causality between housing prices, lending supply, and lending rate. source: Jiang et al., 2018

With reference to the long-run causality results (the external arrows), lending supply and housing price are affecting each other, while lending rate affects housing price. The results agree with our hypothesis.

Wen (2010) also explains the channel from interest rate to housing price as follows:

‘credit and M2 may be driven simultaneously as part of a broader financial intermediation process; a common underlying factor may be the interest rate. A lower interest rate may stimulate borrowing and housing demand, which in turn may induce higher demand for durable goods. Because durable goods are purchased with money, the demand for money may also increase. As a result, aggregate demand and the money supply may increase, which raises the aggregate price level.’ (Wen, 2010)

Similarly, researchers of European Central Bank also found empirical evidence of a significant multidirectional link between house prices, broad money, private credit and the macroeconomy in the EU countries. They found that Shocks to GDP, the CPI and the interest rate are found to have significant effects on house prices, money and credit. (Goodhart and Hofmann, 2008)

The relationship is especially intense in Hong Kong, due to the link exchange rate. As central banks normally would adjust interest rate in the wake of abrupt housing price changes and/or economic condition changes, yet due to the currency board arrangement in Hong Kong, the Hong Kong Monetary Authority (defacto Central Bank) could not adjust nominal interest rate at will, but can adjust loan-to-value ratio and other lending policy.

Chung (2012) has tested empirically the effects of money supply and interest rate on housing price, and found that ‘housing rental, excess liquidity [money supply], stock price and real interest rate are the key determinants of the residential property price in Hong Kong.’ The causality direction from lending rate to housing price is quite consistent in most of the studies.

With the recent increase in interest rate in the US, and the trade war between the US and China, lending supply is reducing and lending rate is increasing. It predicts a decrease in housing price in Hong Kong according to the above theories and findings. Let’s take a look about the actual situations of lending supply and lending rate next week.

Interestingly, the defacto Central Bank of Hong Kong, the Hong Kong Monetary Authority has done an empirical study about the causality direction and made the following conclusion:

'the error-correction models show that property prices determines bank lending, but that bank lending does not appeaar to influence property prices.’ (Gerlach and Peng, 2004, p.20)

For example, when housing price increases by 100%, then even if the loan-to-value ratio is reduced from 100% to 50%, the total mortgage loan amount would still be the same, ceterius paribus.


Chung, K.H.K. (2012) Determinants of Residential Property Prices in Hong Kong: A Cointegration Analysis, International Research Journal of Finance and Economics 96, 55–62. https://pdfs.semanticscholar.org/5ef9/0b3da8b51922273dc7ba02cc1b00a6853800.pdf

Gerlach, S. and Peng, W. (2004) Bank Lending and Property Prices in Hong Kong, HKMA. http://citeseerx.ist.psu.edu/viewdoc/download?doi=

Goodhart, C. and Hofmann, B. (2008) House Prices, Money, Credit and the Macroeconomy, Working Paper №888, April, European Central Bank. https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp888.pdf?aae25e46c7906056e754b9d641d0c10f

Jiang, Y., Zhao, D., Sanderford, A. and Du, J. (2018) Effects of Bank Lending on Urban Housing Prices for Sustainable Development: A Panel Analysis of Chinese Cities, Sustainability 10, 642

Ryan-Collins, J. (2018) Why Can’t You Afford a Home? (The Future of Capitalism), UK.

Wen, Y. (2010) Money Supply, Credit Expansion, and Housing Price Inflation, Economic SYNOPSES. https://files.stlouisfed.org/files/htdocs/publications/es/10/ES1006.pdf

Yiu, C.Y. (2009) Negative Real Interest Rate and Housing Bubble Implosion: an Empirical Study in Hong Kong, Journal of Financial Management of Property and Construction 14(3), 257–270.