Description

Booms in house prices are leading indicators of financial crises. Therefore, understanding their causes is a key policy objective. Although theory suggests that large capital inflows are main factors behind these booms, empirical evidence about their association is still needed. This paper provides methodical evidence on the link between capital inflows and booms in real estate prices, with a specific focus on the composition of capital flows. We find that the positive association between large capital inflows and booms in real estate prices described in previous studies is explained mostly by bank and portfolio flows. In addition, we find evidence suggesting that this association is lower in countries with more flexible exchange rate regimes and with better quality of institutions. Finally, we found some evidence, although not robust, that support the idea that restricting financial development or introducing capital controls can help reduce the association between large capital inflows and booms in house prices.