The Unassuming Economist

An IMF working paper by Nan Geng says that:

“Assessing the sustainability of house price developments has become an integral part of macro-financial surveillance. Many AEs have experienced a remarkable run-up in their national housing markets in the past two decades and in some cases house prices have remained strong in recent years. Understanding housing price developments and monitoring the extent to which house prices deviate from levels supported by long-run fundamental factors are important for assessing risks to financial and macroeconomic stability.

This paper models house prices on a cross-country basis seeking insights on deviations from sustainable valuations. Based on standard theory, it selects a small set of supply and demand fundamental drivers of house prices to model long-run equilibrium house prices in 20 AEs in the OECD. The novel feature of the model is the incorporation of policy, institutional, and structural factors—i.e. tax incentives for home ownership, rent controls, and the long-run supply responsiveness of housing construction. The estimated long-run relationship broadly captures trends in housing prices since the early 1990s. Hence, the uptrend in real housing prices largely reflects fundamentals, especially rising real disposable incomes. On average, the overvaluation of housing prices on current fundamentals is modest, but there are significant variations in the estimated valuation gaps across our sample.

Policy, institutional, and structural factors are found to be important determinants of long-run equilibrium house prices. The impact of shocks to the traditional demand and supply factors on long-run house prices varies significantly across countries depending on policies and structural factors. In particular, more generous tax relief, stricter rent control, and below-average long-run supply responsiveness are found to drive up house prices.

In this regard, structural reforms in the housing market should be considered alongside macroprudential instruments. Structural reforms can over time improve housing affordability, thereby reducing debt accumulation and enhancing financial stability. These structural reforms include, but are not limited to, reforms to raise the long-run elasticity of housing supply, phasing out rent control, and reducing tax incentives for home ownership and debt financing. Such instruments may complement and support the more commonly used macroprudential tools such as limits on loan-to-value ratios, as the impact of reforms on supply and demand fundamentals may shape longer-term expectations in the housing market.”