The impact of China's fiscal and monetary policies on regional disparity in housing prices

Abstract

Ever since the tax reform in 1994 in China, local governments have to rely more and more on land and real estate related fees as a major source of revenue. With the rapid development of the financial sector in China, local governments also rely more on bank loans with real estate assets as collaterals to finance capital expenditure projects and other government expenditure. Many theoretical studies have suggested that the reliance of local governments on land and real estate related revenue has fuelled housing prices and rendered the central government’s policy to contain housing price escalation ineffective. However, so far there has been little vigorous empirical analysis that supports this argument. This study use panel data from 31 provinces over the period 1999 to 2010 to analyses empirically the role of provincial governments’ behavior in determining housing price levels in China. Our empirical results suggest that the behavior of provincial governments has contributed significantly to regional housing price disparity after controlling for social and economic factors. In particular, we found that the level of fiscal autonomy (local government revenue as a percentage of GDP) has an overall positive impact on housing prices and that such impact is stronger for provinces that are geographically more distant from Beijing. We also found that although the central government’s policy on the RMB exchange rate reform in 2005 has an overall positive impact on real housing prices due to inflow of speculative hot money, such impact varied across different provinces and thus also contributed to regional housing price disparity. Our empirical results suggest that speculative hot money tended to flow into housing markets in provinces with a more developed tertiary sector. This is because regions with more developed tertiary sector usually have more mature real estate markets, lower information costs, better financial and legal services, which facilitates flow of fund into and out of the housing market. This study contributes to the body of knowledge on regional housing price disparity. Unlike previous studies that only focused mainly on the impact of economic, social and government planning policies, this study also aimed at studying the role of fiscal and monetary policies in China. The results have important policy and practical implications. First, while the financial incentives and responsibility given to provincial governments may increase economic efficiency, they may also lead to conflicting goals between central and local governments. In addition such financial incentives and responsibility may unexpectedly lead to housing price bubbles that are economically and socially undesirable. Second, the central government’s policy to reform the exchange rate formation mechanism of the RMB in 2005 has also contributed to housing price escalation which may not be desirable from both social and political perspectives. Even worse still, the impact was not uniform but stronger in provinces with a more developed tertiary sector, which are usually wealthier provinces. Increase in housing prices in these provinces may lead to faster regional economic growth and thus contributing to even more sever regional income disparity, which contradicts the central government’s goal of reducing income polarization.