Housing quality improvement, property market dynamics, and sustainable house prices

This paper reviews the literature that examines the circumstances when house prices are likely to become unsustainable. It argues that there are 2 types of unsustainability: - The first type happens when there is a widespread increase in demand for better quality housing, or a rapid increase in population, which leads to a construction boom. Since the number of new houses typically built by the construction sector is much smaller than the stock of houses, the boom may run up against capacity constraints for several years during which time prices rise and then fall back to normal levels. This type of boom could be managed by a central bank but there would be other trade-offs to consider. - The second type of price unsustainability happens when there are technical or regulatory changes that reduce the usual cost of producing new houses. This type of unsustainability reflects supply factors and is typically outside the domain of the central bank. - The paper argues that the demand for better quality housing (which cannot be quickly met from new supply) is a major reason for unsustainable house prices, and a reason why house price cycles are often so different from price cycles in other industries.