The European Financial Crisis was a crippling event in modern economic history. In the aftermath of the crisis, national as well as international, public as well as private institutions are researching the origin of the crisis and ways to prevent a second occurrence. Research and literature show that a determining factor for the crash of the financial markets were construction and housing prices. As a result of this observation a possible explanation for the European Financial Crisis could be found in boom and bust cycles of these industries.
The following paper will briefly introduce the background of the boom and bust cycles based upon the New Keynesian perspective of Endemic Business Cycle as well as the socio-economic background of the crisis. In a next step supporting and opposing arguments of the introduced model are presented, and analyzed.
The paper will conclude that while the boom and bust cycles are not as co-depended as the model indicates, the European Financial Crisis was indeed strongly influenced by the boom and subsequent bust of Construction and Housing prices. The correlation with credit booms played a decisive role in the crash. Thus, authorities are would be well advised to address the correlation in monetary policy.
Table of Contents
I. Introduction
II. Background
A. Socio-economic Background
B. The Boom and Bust Cycle
III. Supporting Arguments
A. 1970-2001 – Findings of the 2003 Helbling Study
B. 2000-2007 – Findings of the 2013 study of the IMF
IV. Opposing Arguments
A. Autocorrelation disproved?
B. Correlation of housing prices and inflation rates
C. Impact of Monetary Policy
V. Conclusion
Research Objectives and Themes
This paper examines the correlation between boom and bust cycles in the construction and housing industries and the onset of the European Financial Crisis, utilizing the New Keynesian perspective of Endemic Business Cycles as a theoretical framework.
- Theoretical analysis of New Keynesian Endemic Business Cycles.
- Evaluation of the relationship between housing market fluctuations and economic growth.
- Comparative analysis of historical studies (Helbling 2003, IMF 2013) on construction shares.
- Critique of the autocorrelation model in economic cycles.
- Assessment of the impact of monetary policy and inflation on financial market stability.
Excerpt from the Book
B. The Boom and Bust Cycle
The European Financial Crisis, as a part of the international Financial Crisis, is often mentioned in relation to the Great Depression in the 1930s. The effect of this worldwide crisis were different in the individual national states, in the United States it caused a recession with devastating effects (Heyne, 2013:363). The recession was not based on one root cause but was built upon a “cluster of errors” (ibid). It is evident, however, that the Great Depression (bust) followed a period of economic prosperity (boom – “Roaring Twenties”) (ibid).
Here the Endemic Business Cycle comes into play. This perspective is based upon fluctuations in business cycles due to shocks (Mankiw, 1989). The New Keynesian Model assumes that every business cycle encompasses phases of economic growth, so called booms, followed by crashes, so called busts (De Grauwe, 2010). This cyclical movement exhibits a “strong autocorrelation” (ibid), meaning that every “boom” is followed by a “bust”. Additionally, the stronger the preceding event, the stronger the reactive event becomes (ibid).
Within “Boom Bust Models” the “boom” period is characterized by increased outputs. These are observable in increased gross domestic products, employment rates or business profits (Mankiw, 1989; De Grauwe, 2010).
The “bust” period, on the other hand, exhibits declining economic growth and thus decreasing gross domestic products, rising unemployment or stagnating business profits (ibid).
Summary of Chapters
I. Introduction: Outlines the scope of the research and the premise that boom and bust cycles in housing and construction were significant contributing factors to the European Financial Crisis.
II. Background: Provides the socio-economic context, including globalization and neoliberalism, and defines the New Keynesian perspective on business cycles.
III. Supporting Arguments: Presents evidence from historical studies (Helbling, 2003; IMF, 2013) that link housing and construction booms to subsequent economic downturns.
IV. Opposing Arguments: Discusses limitations of the autocorrelation model and highlights that housing price declines do not always imply immediate economic recession, considering inflation and monetary policy variables.
V. Conclusion: Summarizes that while the relationship is complex, construction and housing sector instability played a decisive role in the European Financial Crisis.
Keywords
European Financial Crisis, Boom and Bust, Construction Industry, Housing Market, New Keynesian Theory, Endemic Business Cycle, Economic Growth, Monetary Policy, Autocorrelation, Recession, Financial Markets, Inflation, Credit Booms, Globalization, Neoliberalism
Frequently Asked Questions
What is the core focus of this research paper?
The paper investigates whether boom and bust cycles in the construction and housing sectors serve as a valid explanation for the European Financial Crisis.
What are the primary themes discussed?
Key themes include the New Keynesian perspective on business cycles, the socio-economic drivers of the crisis, and the empirical correlation between construction shares and financial stability.
What is the central research question?
The study aims to determine if the European Financial Crisis was strongly influenced by the boom and subsequent bust of construction and housing prices.
Which scientific methodology is applied?
The paper utilizes a literature-based analysis of established economic models and specific studies, such as the 2003 Helbling study and the 2013 IMF study, to support or challenge the hypothesis.
What is covered in the main body of the work?
The main body examines the socio-economic background, provides empirical evidence supporting the boom-bust model, evaluates counter-arguments regarding autocorrelation and inflation, and discusses the role of monetary policy.
Which keywords best characterize this work?
The paper is best defined by terms like European Financial Crisis, boom and bust, New Keynesian theory, housing market fluctuations, and monetary policy.
How does the author define the 'boom' phase within the examined model?
A boom is characterized by increased output, including higher gross domestic product, rising employment rates, and improved business profits.
What role does monetary policy play in the author's conclusions?
The author concludes that authorities should address the link between credit booms and construction shares within their monetary policy to mitigate the risks of future crashes.
- Quote paper
- Jan Alexander Linxweiler (Author), 2016, Booms and Busts in Construction and Housing. An explanation of the European Financial Crisis?, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/343908
