Measuring fundamental housing prices in the Baltic States: empirical approach

Abstract

Purpose -The purpose of this paper is to develop a comprehensive framework for assessing housing price misalignments from the fundamental prices in the Baltic States.Design/methodology/approach -This paper uses several statistical indicators (price-to-rent ratio, priceto-income ratio, price deviations from Hodrick-Prescott filtered trend) together with econometric panel error correction model. The model takes advantage of the reduced form specification of equilibrium prices. Statistical indicators are employed in combination with the model estimates to arrive to clearer conclusions about residential real estate price misalignments.Findings -The results show that using the framework developed in this paper one could have successfully identified the overheating in the residential real estate markets that was happening in [2005][2006][2007][2008]. The estimates also capture the price correction overshooting that happened in the Baltic States after the recession of 2009. Since then, housing prices have been converging to their equilibrium values.Research limitations/implications -The result implies that no immediate restrictive policy action is required. Looking further, the framework developed here can be used to supplement macroprudential monitoring, risk identification and analysis. It should also help fine-tune various policy instruments that have an impact on the real estate markets.The limitations of the framework presented in this paper suggest at least two directions in which the research could be improved and extended. First, it would be useful to extend the current modelling setup to VECM framework for the better understanding of error correction dynamics. Second, better time series would potentially improve the quality of the results as the series used in this paper in some cases had to be extrapolated or interpolated (or were not sufficiently long enough).Originality/value -This paper contributes to the literature by filling the gap of monitoring housing market developments consistently in the Baltics and developing a framework that can potentially be used to monitor price misalignments in the residential real estate markets of other countries..

The user cost of housing in the Baltic states

“…There is no doubt that sound real estate markets are instrumental for financial stability, yet little has been done to improve the understanding of the housing market cycles in the Baltics. With the exception of the recent attempts by Kulikauskas (2015), there is no framework for these countries to identify residential real estate price departures from their fundamental values. While it can be argued that the macroprudential policy measures that came into effect after the crisis of 2008-2009 limits the scope of possible price misalignments, it also means that, in a way, policy makers are conducting it while being blindfolded.…”