Speculation Does Not Explain Apparent Housing Overvaluation
Speculation does not explain all the apparent “overvaluation” of housing markets in Europe, Oxford Analytica argues in a new report.
The probability of a downward correction to housing prices depends on how much residential property prices have diverged from their fundamentals, such as interest rates and wage inflation, OxAn says. A 2008 IMF study and 2005 OECD report concluded that the largest ‘unexplained’ house price increases in the EU were in Ireland, the Netherlands and the United Kingdom. In Belgium, Denmark and Spain, signs of overvaluation are more moderate. For France, Italy and Sweden, there is also evidence of important overvaluation, but the OECD and IMF results diverge markedly for these countries.
But ‘unexplained’ housing prices are not necessarily a sign that housing markets are overvalued and heading for a downward correction, OxAn says.
“While demand from residents and non-residents, for either buy-to-let or secondary residences, may have led to more speculative-like price increases, speculation is not the only factor in overvaluation. Observed price gaps can be due to omitted fundamental determinants of housing prices. General economic factors (such as other asset prices) and demographic factors (such as net immigration, average household size or the share in total population of those aged 30-40) all contribute to increased demand for housing. According to the OECD, the decline in the share of those in their 30s in Germany and Japan, would explain house price declines/stagnation. Complex local zoning regulations such as in Ireland, the Netherlands and the United Kingdom can lead to housing supply shortages.”
“While housing market conditions are part of the set of indicators that central banks regularly follow, assigning an active house market objective to monetary policy as recently suggested by policymakers may be dangerous,” OxAn says.
There is so far no clear evidence that raising interest rates when house price inflation is rising and lowering them when property prices decline will smooth out the business cycle.
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