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Prakash Loungani
From a
I
N 1625, Pieter Fransz built a house in in value in 10 years, only to begin another
Amsterdam’s new Herengracht neigh- sharp decline. This recent run-up and cor-
historical borhood. As the Dutch Republic rose rection in prices in Amsterdam was part of a
perspective, to global power in the 1620s—with
Amsterdam developing the world’s first
global boom and bust in house prices. House
prices soared in the United States, fueled by
it is not the major stock market as well as commodities innovations in housing finance. They also
trend but and futures markets—the price of the house
doubled in less than a decade. Over the suc-
rose in Ireland, coinciding with a historic
growth surge; in Spain and Australia, buoyed
the volatility ceeding three centuries, the price of Fransz’s by immigration; and in Iceland as part of a
in housing house was knocked down by wars, recessions, boom induced by a tremendous expansion in
and financial crises and rose again in their the country’s financial sector. In 2006, house
prices that is aftermaths (Shorto, 2006). When the house prices started to fall, first in the United States
distinctive changed hands in the 1980s, its real value,
Loungani
and then elsewhere (see Chart 2).
that is after inflation, had
only doubled over the course
Chart 1
of 350 years––offering a very
modest rate of return on the The long view
investment. Between 1628 and 2008 house prices in the Herengracht
Indeed, viewed over the long neighborhood rose and fell, but on average the real price
course of history, the distinc- doubled.
tive feature of house prices (1628 = 100)
ing forces behind these cycles? And what does this analysis Korea, the Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland, the United Kingdom, and
the United States.
tell us about the future of house prices? 2Real prices, from trough to peak.
3Real prices, from peak to trough.
Loungani
just over five years, during which real (inflation-adjusted) Driving forces behind house price cycles
prices increased an average of 40 percent (see table). The Why do house prices go through the cycles shown in the
subsequent downturn typically lasted four and a half years, table? Both long-run relationships and short-run forces are
and prices fell about half as much as they rose during the at work.
upturn. Long-run relationships: Economic theory asserts that house
The past offers a prism through which to view the pres- prices, rents, and incomes should move in tandem over the
ent house price cycle, which started sometime between the long run. Why? Consider house prices and rents first. Buying
mid-1990s and early 2000s for most countries. The upturn and renting are alternate ways of meeting the need for shel-
in this most recent cycle lasted twice as long on average as ter. In the long run, therefore, house prices and rents cannot
those in the past (41 quarters compared with 21 quarters) get out of sync. Were that to happen, people would switch
and was more pronounced, with prices rising nearly three between buying and renting, bringing about adjustments
times as much. The ongoing downturn is approaching the both in prices and rents to bring them back in line. Likewise,
duration of past downturns, and the fall in house prices thus in the long run, the price of houses cannot stray too far from
far is nearing the amplitude of past downturns. But because people’s ability to afford them––that is, from their income.
prices rose much more sharply than in earlier upturns, their Take, for example, these long-run relationships in the
Lounganimight eclipse those observed in the past.
decline United States and Loungani
the United Kingdom (see Chart 3). The
Chart 3 Chart 4
Joined at the gables Propelling house prices
In the United States and the United Kingdom, as in many countries, rents and incomes Strong income and population growth can
move with house prices. give a mighty push to real house prices as
(ratio) (ratio) happened in Ireland after 1992.
(average annual growth, percent)
1.35 1.65 United Kingdom
United States 25 1.6
1.30 1.55 GDP (left scale)
Population (right scale) 1.4
1.25 1.45 20
House price–to-rent ratio House price–to-income ratio
1.20 House prices (left scale) 1.2
1.35
1.15 1.25 15 1.0
Long-term
1.10 Long-term average average 0.8
1.15
10 0.6
1.05 1.05
1.00 0.95 0.4
5
0.95 0.85 0.2
0.90 0.75 0 0.0
1970–91 1992–06
1970 80 90 2000 08 1970 80 90 2000 08
Sources: Author’s calculations based on IMF and Organization
Source: Organization for Economic Cooperation and Development. for Economic Cooperation and Development data.