Does local governments’ budget deficit push up housing prices in China?

Article history: Received 4 March 2014 Received in revised form 12 August 2014 Accepted 12 August 2014 Available online 23 August 2014 Budget deficit has been a commonfiscal pressure facing Chinese cities since the 1994fiscal reform. Meanwhile, land lease sales have become a significant off-budgetary revenue to local governments since 2003. This paper investigateswhetherfinancing budget deficit is an important driving force of the recent soaring housing prices when local governments function as the monopoly supplier of urban land. A conceptual framework is developed to illustrate a transmission mechanism from budget deficit to housing prices. This leads to an empirical model consisting of two simultaneous structural equations for housing prices and land prices. Using data for the 35major Chinese cities from 2003 to 2011, an empirical exercise shows that although budget deficit has a positive effect on land prices, it is the factors from demand side, such as amenities, income and the user cost of housing capital, that have been pulling up the housing prices. © 2014 Elsevier Inc. All rights reserved. JEL classification: R21 R31 H27 G10