Bubbles in the Taiwan housing market: The determinants and effects I-Chun Tsai a, * , Chien-Wen Peng b a Department of Finance, National University of Kaohsiung, No. 700, Kaohsiung University Rd., Nanzih District, 811. Kaohsiung, Taiwan, ROC b Department of Real Estate & Built Environment, National Taipei University, Taiwan, ROC JEL classification: R31 Keywords: Housing market Cointegration Panel data Bubbles Housing affordability abstract This paper uses house prices in four Taiwanese cities to test whether there are bubbles in the Taiwan housing market. Panel data tests are employed to determine whether the movement of house prices diverges from that of household income and rent. Following the framework of Mikhed and Zem cík (2009), this paper constructs the bubble indicator for the Taiwan housing market. The relationship of the market with mortgage rate, money supply, inflation rate, economic growth rate, homeownership rate, and user cost for housing is also discussed. The empirical finding shows that the policy on money supply in Taiwan is most likely related to bubbles in the sample period. Although the annual increase in homeownership rate in Taiwan is encouraging, this does not mean the public is not burdened by a housing bubble. The evidence presented in this paper may provide implications for policy reforms by the government. Ó 2010 Elsevier Ltd. All rights reserved. Introduction Taiwan’s housing market has always been highly volatile, with obvious ups and downs. Historical price data show several periods of bubbles and recessions. House prices in Taiwan have undergone three major cycles from 1970 to the present. Prices approximately doubled in the first and second peaks during the early and late 1970s. The third peak occurred in the late 1980s when house prices tripled in value. Prices during that time were far higher than what an average household could afford, and the cycle lasted for a long time. Every market bubble and recession creates numerous problems, including income redistribution. As a result, the macroeconomic market is filled with speculative capital demand and supply, causing inefficiency in the operation of various markets. In an emerging market like Taiwan, the government’s minimal control over the housing market is important because a market that goes out of control may create social problems in addition to economic problems. How disadvantaged groups afford housing is of partic- ular concern during an economic bubble. Therefore, government interference in the housing market occurs relatively frequently even if policymakers in Taiwan believe in a free economy. When the housing market or the overall economy is on a downturn, the government often encourages banks to adopt a lenient mortgage policy, implements policies favorable to construction companies, and subsidizes disadvantaged groups through preferred loan rates. Conversely, when the market is overheated, the government imposes fewer controls, making many people, especially those who cannot afford a house, feel unfairly treated. For example, at the end of 2007, the world was affected by the subprime mortgage crisis in the United States. In response, Taiwan’s government imposed various market stimulus policies. Lenient monetary policies and resulting foreign capital inflow in 2009 overheated the Taiwan housing market, but no countermeasures were taken as a response. Railing against the asymmetric policy, many people were worried that increasing house prices would make it impossible for them to buy a house. The problem of bubbles is, therefore, more serious than price drops. Even with the relatively few measures for market bubbles, few studies used house price- to-income ratio (PIR) as a variable to analyze housing affordability. For example, Hsieh (1996) examined the linkage among house price, housing affordability, tenure choice, and homeownership rate. Hsieh proposed that the affordability problem in Taiwan had been easing because house PIR had decreased steadily from 1960 to 1975, but worsened when prices increased sharply thereafter. Kau, Chang, and Lin (2000) investigated whether there is a reasonable PIR for different household income distributions in Taiwan. They suggested that PIR in Taiwan is relatively higher than in other developed countries. Different household income distri- butions in Taiwan also have different PIRs, and because of the lack of low-price housing, the affordability problem for low-income households is worsening. These two studies suggest that the housing affordability problem in Taiwan is worsening. * Corresponding author. Tel.: þ886 7 5919767. E-mail address: ictsai@nuk.edu.tw (I-C. Tsai). Contents lists available at ScienceDirect Habitat International journal homepage: www.elsevier.com/locate/habitatint 0197-3975/$ e see front matter Ó 2010 Elsevier Ltd. All rights reserved. doi:10.1016/j.habitatint.2010.11.010 Habitat International 35 (2011) 379e390