This paper assesses how the degree of the mortgage market flexibility alters the effect of a residential house price shock on household credit and GDP. We estimate a panel vector auto regression model for a sample of 16 OECD countries for the period 1985Q1-2012Q4 and we identify a house price shock as an increase in the innovation term of house prices unrelated to the contemporaneous changes in output and inflation. Our results do not support the hypothesis of a stronger household credit and GDP response to a house price shock in countries with a more flexible mortgage market.

The recent great financial crisis has illustrated the devastating impact that large negative house price shocks can have on the credit availability and household consumption in many countries. Subsequently, the role of house prices in the macro-economy has been investigated intensively during the last decade (Muellbauer and Murphy, 2008). Recently, there is increased attention for the question to which extent the impact of residential house price shocks on household credit and GDP is stronger for countries with a more flexible mortgage market, characterized by mortgages with a high loan to value ratio (LTV), low transaction costs of mortgage refinancing, and access to second mortgages and home equity loans. Differences in the macroeconomic effects of house price shocks are expected to arise since an illiberal mortgage market largely turns off several of the transmission channels for both existing homeowners and future first time buyers.