The link between house prices and the macroeconomy in Malta

Abstract

Malta’s geography, history, and culture have turned the housing market into a scarce and desirable resource. This dissertation assesses the link between house prices and some key macroeconomic factors in Malta for approximately the last decade (2004Q1 to 2014Q3). A ‘Property Price Index’ represents the country’s house prices over time. The ‘Nominal Compensation of Employees’ as a function of economic activity is employed whereas bank credit and interest rates are represented by ‘Nominal Lending for House Purchase’ and ‘Lending for House Purchase Interest Rate’ respectively. Using a Vector Autoregression (VAR), this dissertation employs the Granger causality test and finds a unidirectional causal relationship running from the compensation of employees, bank credit, and interest rates to house prices. Furthermore, an impulse response analysis is carried out to determine the reaction of house prices to a positive shock to itself, as well as to the three house price determinants. The analysis shows that a positive shock to house prices and to the compensation of employees will significantly increase house prices but only in the short-run. A shock to bank credit will increase house prices to a lesser extent but the effect remains evident in the long-run. Finally, a shock to interest rates seems to increase house prices in the future, thereby contradicting economic theory.