In recent years, global imbalances have channeled the excess savings of surplus countries toward the real estate markets of deficit countries. By consequence, the deficit countries that attracted lots of foreign capital experienced large run-ups in house prices while the surplus countries that exported capital exhibited flat or slow house price growth. We argue that international capital flows affect the fiscal policy preferences of both voters and political parties by way of their impact on housing prices. Where capital inflows are large and housing prices are rising, we expect voters to respond by demanding both lower taxes and less publicly-provided social insurance. This is because rising house prices allow homeowners to “self insure” against income losses due to unemployment, illness, and old age. We present survey evidence that supports this claim. Furthermore, we find that responses to house prices are mirrored in capital exporting countries: households become more supportive of both taxes and social insurance as home prices remain flat or decline. Finally, we show that political parties are the mechanisms through which the fiscal preferences of households find policy expression. Taxes and social insurance spending tend to fall (rise) where the right (left) is in power and capital inflows are driving up housing prices. In capital exporting nations, by contrast, we find an attenuation of these partisan fiscal policy outcomes.
Systemic Risk Centre Discussion Papers DP 31