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Forecasting and assessing Euro area house prices through the lens of key fundamentals

  • Gattini, Luca
  • Hiebert, Paul

This paper presents a parsimonious model for forecasting and analysing euro area house prices and their interrelations with the macroeconomy. A quarterly vector error correction model is estimated over 1970-2009 using supply and demand forces central to the determination of euro area house prices in equilibrium and their dynamics: housing investment, real disposable income per capita and a mixed maturity measure of the real interest rate. In addition to house price forecasts using the resulting reduced form equation, a structural decomposition of the system is obtained employing a common trends framework of King, Plosser, Stock, and Watson (1991), which allows for the identification and economic interpretation of permanent and transitory shocks. The main results are twofold. First, the reduced form model tracks closely turning points in house prices when examining out-of-sample one- and two- step ahead forecasts. Moreover, the model suggests that euro area housing was overvalued in recent years, implying a period of stagnation to bring housing valuation back in line with its modelled fundamentals. Second, housing demand and financing cost shocks appear to have contributed strongly to the dynamism in euro area house prices over the sample period. While much of the increase appears to reflect a permanent component, a transitory component has also contributed from 2005 onwards. Specification tests suggest a robustness of the small model to alternative specifications, along with validity of the long-run restrictions. JEL Classification: R21, R31, C32

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Paper provided by European Central Bank in its series Working Paper Series with number 1249.

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Date of creation: Oct 2010
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Handle: RePEc:ecb:ecbwps:20101249
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  1. Giannone, Domenico & Reichlin, Lucrezia, 2006. "Does Information Help Recovering Structural Shocks from Past Observations?," CEPR Discussion Papers 5725, C.E.P.R. Discussion Papers.
  2. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  3. Bharat Barot, 2001. "An Econometric Demand�Supply Model For Swedish Private Housing," European Journal of Housing Policy, Taylor and Francis Journals, vol. 1(3), pages 417-444, December.
  4. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-44, January.
  5. Glaeser, Edward & Saiz, Albert & Gyourko, Joseph, 2008. "Housing Supply and Housing Bubbles," Scholarly Articles 2962640, Harvard University Department of Economics.
  6. Matteo Iacoviello & Stefano Neri, 2008. "Housing market spillovers: Evidence from an estimated DSGE model," Temi di discussione (Economic working papers) 659, Bank of Italy, Economic Research and International Relations Area.
  7. Stephen Malpezzi, 1998. "A Simple Error Correction Model of House Prices," Wisconsin-Madison CULER working papers 98-11, University of Wisconsin Center for Urban Land Economic Research.
  8. Hecq, Alain & Palm, Franz C & Urbain, Jean-Pierre, 2000. " Permanent-Transitory Decomposition in VAR Models with Cointegration and Common Cycles," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 62(4), pages 511-32, September.
  9. Darracq Pariès, Matthieu & Notarpietro, Alessandro, 2008. "Monetary policy and housing prices in an estimated DSGE for the US and the euro area," Working Paper Series 0972, European Central Bank.
  10. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
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