Housing Price Volatility and the Capital Account in China

China experienced significant volatility in its housing market from 2005-2013. Economists analyzing the determinants of volatility in these markets find that the bubble was largely driven by factors specific to the Chinese economy and Chinese economic policy.

In a 2015 working paper, Yuan Tian and Kevin P. Gallagher examine the extent to which short-term capital flows impacted China’s housing prices and their volatility. They also assess the effectiveness of China’s 2006 Capital Account Regulations (CARs) on foreign purchases of Chinese real estate in reducing the level and volatility of prices in China’s housing markets.

Main findings:

• Short-term capital flows from abroad had a modest impact on price increase in the Chinese housing market, but a more significant impact on increasing market volatility. 
• China’s 2006 CAR policy measures did not appear to have an impact on reducing housing prices, but had a strong impact on reducing volatility in the Chinese housing market.
• Hot money, another term for short-term capital flows, magnified the impacts of capital flows on housing prices during upward surges in the housing price. 
• The more volatile the housing market became the larger the impact short-term capital flows had on accentuating such volatility. 
• The 2006 CARs continued to have a strong impact on reducing volatility in the Chinese housing market between 2005-2013.

China’s housing bubble has appeared to ebb to some degree, but as China liberalizes its capital account, it will have to devise mechanisms to evaluate the impact of capital flows on asset prices and may need to resort to temporary regulations on capital inflows. The authors believe these policies can be moderately effective.