Real House Prices In The Uk

The housing market plays a fundamental role in the economy, and its functioning affects both consumer welfare and economic stability, as the recent crisis has made clear. Research by Barrell et al. (2010) shows that house prices are a key determinant of financial crisis probabilities in OECD economies, and contribute significantly towards systemic banking risk. This must lead the regulator to assess carefully the role of the housing market in this relationship, and if necessary impose regulatory restrictions on the market so as to ensure it functions in a way that reflects the best interests of the economy. In this note we look at the evolution of real house prices in the UK, noting that they have a strong cyclical pattern. We then look at the factors that might affect the evolution of real house prices, and we estimate a dynamic equation describing those prices. After considering a wide set of factors, we demonstrate that there is little role for the supply of housing relative to the number of households. This may be because the ratio of these two variables has been relatively constant over the past thirty years. We show that real borrowing costs, real incomes and the loan-to-income ratio are significant factors determining the long-run path of real house prices, and that front loading problems from high short-term nominal interest rates affect the path of adjustment. Overvaluations can persist for years, and we would judge that real house prices are currently fundamentally overvalued by around 10 per cent. If loan-to-income ratios are reduced then the fundamental overvaluation will increase, and such a policy will put further downward pressure on real house prices.(This abstract was borrowed from another version of this item.)