Misalignments in house prices and economic growth in Europe

Abstract

In this paper we investigate house price misalignments and how they affect the real economy. We estimate the long-term relationship between house prices and the fundamentals that determine long-term house prices for a panel of European countries with dynamic OLS, using data from 2005-2018. We find that income has been the main driver of fundamental house prices in all countries, while the supply of dwellings has calmed the rise in house prices in some of them. We calculate house price misalignments, which are deviations of house prices from the fundamental value, and we employ them in the growth model. The results of the growth regression indicate that house price imbalances amplify business cycles in the short term, but in the long term house price overvaluations slow economic growth down. The findings imply that it is crucial to take measures to stabilise housing cycles.

Impact of House Price on Economic Stability: Some Lessons from OECD Countries

“…Furthermore, there is a shortage of empirical work examining the relationship between housing price volatility and economic volatility. Although there are studies that look at the impact of housing price volatility on economic growth (Dolde & Tirtiroglu, 2002 ) or on residential investment and price misalignment on the business cycle (Cuestas et al, 2022 ; Davis & Heathcote, 2005 ), there is no work that directly assesses the relationship between housing price and economic volatility 3 . Hence, further research is necessary to investigate this relationship.…”