House prices and credit cycles: the case of Cyprus

Abstract

Purpose - The purpose of this paper is to assess whether the rapid accumulation of bank deposits before the global financial crisis and their subsequent drastic reduction was the main driving force of the Cyprus house price cycle over the period 2006–2015. Design/methodology/approach - To this aim we estimate a three-equation model in which house prices are determined by housing loans, among other factors, and housing loans are determined by bank deposits. All equations are estimated using partial adjustment model specifications. Findings - Our findings indicate that housing loans, which capture the effect of credit availability on housing demand, had the smallest effect on house prices, thus providing little support to our proposition of a deposits-driven cycle in house prices. Research limitations/implications - The main limitation of the study is the use of the housing loan stock instead of the actual volume of housing loans in each period due to lack of such data. As a result our econometric estimates may not accurately capture the magnitude of the effect of housing loans on house prices. Practical implications - The study has important practical implications for policy makers as it highlights the importance of availability of credit in supporting effective demand for housing during periods of economic growth. Furthermore, it highlights the key role of house price increases in combination with the collateral effect in driving the house price cycle. Originality/value - This is among the few studies internationally and the first study in Cyprus that attempts to link econometrically the credit and house price cycles that were caused by the global financial crisis.