Housing Price Dynamics BIS

What drives housing price dynamics: cross-country evidence
Kostas Tsatsaronis and Haibin Zhu.


A house is the largest single asset of most households, and assets whose value is linked to residential real estate represent an important component of the aggregate portfolio of financial intermediaries. The behaviour of house prices, therefore, influences not only business cycle dynamics, through their effect on aggregate expenditure, but also the performance of the financial system, through their effect on the profitability and soundness of financial institutions. Understanding this behaviour is thus of key interest to central banks charged with maintaining price and financial stability.

This broad overall picture, however, ignores considerable differences in the experience of individual countries. During this period, housing price growth was particularly strong in Ireland, the Netherlands and the United Kingdom, which experienced average annual growth rates in excess of 11%. This group is followed closely by Australia, Spain and a number of Nordic countries, where the pace of growth has accelerated in more recent years.


At the other end of the spectrum one finds Germany and Switzerland, where prices have remained rather flat recently even though the latter experienced a boom and bust cycle in the late 1980s and early 1990s. Similarly, there has been a downward trend in real house prices in Japan since the bursting of the so-called “bubble economy” in the early 1990s.


A useful distinction in the demand and supply factors that drive real housing prices is between those that have a longer-term influence and those that affect shorter-term dynamics. Factors that influence the demand for housing over longer horizons include growth in household disposable income, gradual shifts in demographics (such as the relative size of older and younger generations), permanent features of the tax system that might encourage home ownership as opposed to other forms of wealth accumulation, and the average level of interest rates (possibly related to the long-run behaviour of inflation). The availability and cost of land, the cost of construction and investments in the improvement of the quality of the existing housing stock are longer-term determinants of housing supply.

Housing markets, however, are intrinsically local in character. As such, the growth of the housing stock can be constrained in the short run as a result of a number of factors that include the length of the planning and construction phases and the inertia of existing land planning schemes. This suggests that idiosyncratic, national factors can lead to significant differences in the dynamics of prices across countries.4 One set of such factors relates to the prevailing conditions in the provision of financing for the purchase of housing. Another factor affecting the liquidity of the housing market is the specific transaction cost framework such as the level of VAT, stamp and registration duties and inheritance taxes. Finally, the uncertainty about future prospects that follows periods of heightened volatility in housing prices tends to lead to a more cautious response of housing construction to shifts in demand because of the inherent irreversibility of this type of investment.

Residential real estate prices are characterised by long swings. Graph 1 plots inflation-adjusted house prices for 17 industrialised economies between 1970 and 2003. Each country experienced about two full cycles over this period of 33 years.


The empirical framework

The model includes five endogenous variables besides house price growth:

(i) the growth rate of GDP, which provides a measure of the state of the business cycle and household income; (ii) the rate of inflation in consumer prices, which is the only nominal variable in the system; (iii) the real short-term interest rate, which is closely linked with the monetary policy stance; (iv) the term spread, defined as the difference in yield between a long-maturity government bond and the short rate; and (v) the growth rate in inflationadjusted bank credit.