The Dynamics of Housing Prices
May 27, 2003
What causes house price fluctuations? Using data for 62 U.S. metropolitan areas from 1979 to 1995, researchers found that both information dissemination and supply factors influence house prices.
Real house prices react differently to economic shocks depending on such factors as the growth rates of the underlying population and real income in the area, the size of the area, and construction costs.
Some areas may react faster or more strongly to a given economic shock than other areas. In particular, any given positive economic shock will be easier for an area to absorb if the housing stock can be increased quickly and at low cost.
- The authors find that high real income growth in an area has about three times as large an effect on momentum -- the tendency of housing prices to move together in the short run -- as on cyclical house prices.
- They also show that high real construction costs will raise momentum but lower cyclical returns toward trend.
- That combination of large momentum and low cyclical response leads to real house prices continuing to rise beyond their equilibrium values even after the economic growth has slowed, causing as much as 25 percent overshooting and an eventual fall in real prices.
This result is consistent with the extreme behavior of house prices in markets such as Los Angeles and Boston in the 1980s, where large increases in real incomes were coupled with high real construction costs.
Source: "What Causes House Price Fluctuations?" NBER Digest, May 2003; based upon Dennis Capozza, Patric Hendershott, Charlotte Mack and Christopher Mayer, "In Determinants of Real House Prices," NBER Working Paper No. 9262, October 2002, National Bureau of Economic Research.
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