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The Housing Market and the Macroeconomy: Evidence From Ireland

  • Kenny, Geoff

    (Central Bank and Financial Services Authority of Ireland)

This paper provides an empirical assessment of the important linkages which may exist between the housing sector and several key macroeconomic variables. The analysis focuses on (i) the effects of rising real incomes on house prices, (ii) the impact of monetary policy, i.e. interest rates, on developments in the housing market, (iii) the nature and speed of price adjustment in the housing market, (iv) the nature and speed of supply adjustment in the housing market and (v) potential impacts of rising real house prices on real consumption. The key empirical result in the paper is the identification of two long-run relationships which capture the fundamental economic behaviour on both the demand and supply sides of the housing market. In the long-run, the demand side of the market can be modelled using a stable relationship between house prices, the housing stock, income and mortgage interest rates. It was discovered that an increase in income results in a proportional rise in the long-run demand for housing. In addition, the demand for housing responds negatively and proportionately to increases in the price of housing. Mortgage interest rates were also shown to exert a significant negative effect on the demand for housing. To model the supply side of the market, the empirical section of the paper tested the data for the existence of a stable ratio of house prices to construction costs which is consistent with "normal profits" in the house building sector. The housing stock is shown to adjust positively in order to ensure the stability of this profit ratio. Based on this characterisation of housing demand and supply, it would seem possible to explain much of the recent rise in house prices as an efficient relative price change in the presence of very sluggish supply adjustment. In addition, the model suggests that, given the short-run fixity of supply, it is reasonable to expect that house prices will overshoot their equilibrium level and then subsequently decline somewhat.

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Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 1/RT/98.

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Length: 65 pages
Date of creation: Mar 1998
Date of revision:
Handle: RePEc:cbi:wpaper:1/rt/98
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  1. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
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  4. Pesaran, M. Hashem & Shin, Yongcheol, 1996. "Cointegration and speed of convergence to equilibrium," Journal of Econometrics, Elsevier, vol. 71(1-2), pages 117-143.
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  9. Gonzalo, Jesus, 1994. "Five alternative methods of estimating long-run equilibrium relationships," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 203-233.
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  11. Takatoshi Ito & Keiko Nosse Hirono, 1993. "Efficiency of the Tokyo Housing Market," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 11(1), pages 1-32, July.
  12. Hall, Stephen & Psaradakis, Zacharias & Sola, Martin, 1997. "Switching error-correction models of house prices in the United Kingdom," Economic Modelling, Elsevier, vol. 14(4), pages 517-527, October.
  13. Poterba, James M, 1984. "Tax Subsidies to Owner-occupied Housing: An Asset-Market Approach," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 729-52, November.
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  16. Blanchard, Olivier J, 1981. "Output, the Stock Market, and Interest Rates," American Economic Review, American Economic Association, vol. 71(1), pages 132-43, March.
  17. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  18. Miles, David, 1992. "Housing markets, consumption and financial liberalisation in the major economies," European Economic Review, Elsevier, vol. 36(5), pages 1093-1127, June.
  19. Jo Corkish & David Miles, 1994. "Inflation, inflation risks and asset returns," Bank of England working papers 27, Bank of England.
  20. Smith, Lawrence B & Rosen, Kenneth T & Fallis, George, 1988. "Recent Developments in Economic Models of Housing Markets," Journal of Economic Literature, American Economic Association, vol. 26(1), pages 29-64, March.
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