50 years ago the correlations between property prices and the business cycle (fluctuations in GDP growth, interest rate changes, etc) began to be explored by economists.

The question: What really explains changes in property prices?

First shot at an answer: The health of the wider economy and financial conditions.

Initially this seemed a great way to answer the question, since house prices are cyclical, like so much else in the economy.

Yet what emerged from the research was complicated. House buyers are affected by economic growth, inflation, and interest rates, confirming what economists had assumed. However house prices are only roughly correlated with these growth indicators. The correlation is frustratingly imprecise.

Those crazy cycles

House prices move in smooth, long cycles – which would be unlikely, if house prices closely reflected recent changes in economic conditions.

So the economists’ first shot at an explaining house prices, hit a brick wall of fact. Housing cycles are often quite different – deeper, longer – than economic cycles.

A big part of the answer emerged in research conducted 20 years ago by two path-breaking economists, Karl Case and Robert Shiller.

They showed that house buyers, when asked why they are buying, pay amazingly little attention to ‘fundamental’ economic factors. They pay much more attention to recent house prices changes, whether house prices have moved up or down. An extremely important influence on house buyers in period ‘T’ is the behaviour of house prices in period ‘T-1’.

The long cycle leading to 2007

For 20 years before 2007-8, house prices just cycled up.

Interest rates were lower than ever in living memory. New financial products kept on being introduced (none of the regulators had actually experienced 1929-33). Buyers saw prices rise. ‘What’s going to happen in T’? Just look at T-1!’

They bought, and they bought, and they pushed prices well out of line with what they could really afford, and then – poetic justice - interest rates spiked. Result – crash!

Interest rates and market structure

The housing market’s dramatic upward movement, in response to interest rate reductions over the past 20 years, made researchers focus on something they’d ignored in the past.

They realised that buyers are highly sensitive to nominal interest rates. Previously, economists had tended to assume that real (after inflation) interest rates would be critical. But it emerged that buyers are cash-constrained. Reductions in nominal interest rates, and developments in the financial markets (e.g. new mortgage products), dramatically increase willingness to buy houses.

This fact hit home hard in 2008.

This academic focus on interest rates shifted attention to another issue: market context - above all, the structure of mortgage products (floating or fixed) in different countries.

A very diverse picture emerges. Predictions about housing markets in general are agonizingly hard to make. Different tax rates, subsidies, and demographic developments further complicate the picture.

Research increasingly focuses on understanding the key differences between markets, and their impact on the transmission of changes in economic variables (GDP growth, inflation changes, interest rates changes, etc).

Nevertheless, some major trends emerge:

  • Strong economic growth tends to spur demand for housing
  • Low interest rates encourage buyers
  • Floating rate mortgage market structures are associated with volatile housing markets
  • Cycles are important, because buyers are influenced by recent price movements


A selection of the key articles in the academic literature on the determination of house prices, with brief summaries by the Global Property Guide team.

The behaviour of home buyers in boom and post-boom markets
Karl Case and Robert Shiller, November 1988

When making decisions about what should be paid for a house, the study suggests, buyers rely largely on news about recent house prices – i.e., their expectations about price growth in period T, are largely formed by news about house price growth in period T-1. House prices are clearly not ‘efficient’ in the sense of responding to news about housing demand and supply.

A long run house price index: The Herengracht Index, 1628-1973
University of Limburg, Piet Eichholtz, August 1996

The longest house price time-series in existence! The Herengracht index records house sales and purchases on Amsterdam’s famous canal from the date of construction (1628) to recently (1973) (4,253 transactions).

So is property a great long term investment? Not for capital growth!

The study suggests that there was only 0.45% per year increase in house prices between 1629 and 1972/3, despite 20-fold nominal price rises. If 1632 had been chosen as the base year, the real increase would have been zero.

Conclusion: In the very long term, house prices tend to rise at the rate of inflation.

Explaining changes in house prices
BIS Quarterly Review, Gregory Sutton, September 2002

Looks at house price increases in US, UK, Canada, Ireland, Netherlands and Australia 1995-2001. The article suggests that 3 factors have been important ‘movers’ of house prices – GDP growth, interest rates, and equity prices.

  • A 1% increase in GNP growth is associated with a 1% - 4% house price rise after 3 years, an effect especially strong in Ireland.
  • A 1% decrease in interest rates is associated with a 1/2% - 1% house price rise after 1 year.
  • Higher equity prices produce higher house prices in all countries, but the effect is specially strong in the UK. The authors suggest that this could be because equity price rises forecast GNP growth.

Each factor explained about 7%-15% of house price changes over a 3-year period.

Structural factors in the EU housing markets
European Central Bank, March 2003

A study suggesting that the principal factors affecting house prices include:

  1. Household incomes
  2. Interest rates (real and possibly also nominal)
  3. Household formation or other demographic variables
  4. Supply side variables;
  5. Financial market institutions and credit availability, and
  6. Taxes, subsidies and other public policies directly related to housing

Twin peaks in equity and housing prices
BIS Quarterly Review, Claudio Borio and Patrick McGuire, March 2004

Since the 1970s stock market price peaks have tended to precede housing price peaks, with a lag of around 2 years, according to this study of 13 industrial countries.

  • House price peaks tend to occur in the wake of comparatively strong economic conditions, especially when accompanied by credit and equity price growth (‘financial imbalances’).
  • Increases in interest rates, specially nominal interest rates, are of major importance in bringing to a halt rising housing prices.
  • The size of the subsequent house price decline is related to the size of the previous increase, as is typical of boom-bust cycles. House price declines are especially large where there have been financial imbalances.

In conclusion: equity price peaks have predictive power. An equity peak doubles the likelihood of a subsequent house price peak.

What drives housing price dynamics: cross country evidence
BIS Quarterly Review, March 2004

Interest rates are usually considered centrally important in the determination of house prices, but this article shifts attention to a factor arguably underlying changes in interest rates – changes in inflation.

High inflation:

  • Raises house prices in the zone of countries characterized by fixed interest-rate mortgages without equity withdrawal (e.g.: Germany), where housing investment is seen as an inflation-hedge.
  • Has a negative effect on house prices in:
    1. The zone of countries characterized by floating interest rates (e.g.: the UK)
    2. The zone characterized by fixed interest rates with equity withdrawal (e.g.: the US).

In these zones house prices are strongly affected by changes in nominal interest rates.

House prices depend on previous house price rises, economic growth, interest rates, affordability, credit growth, and the current stock of housing supply.

Housing markets and the business cycle
Pietro Catte, Nathalie Girouard, Robert Price and Christophe André, OECD 2004

Three current policy issues - 1. The global house price boom
IMF World Economic Outlook September 2004, Marco Terrones

Looks at the linkages between housing markets and the business cycle in ten OECD countries.

Real house price movements tend to lag cyclical peaks and troughs -- but in ways that differ not only across countries but also from one cycle to another.

These differences appear to be connected both to macro-economic factors (such as inflation variability) but also structural factors. House prices seem to be subject to larger oscillations in countries where housing supply is relatively inelastic and where a favourable tax treatment of mortgage interest encourages the leveraging of housing equity.

Recent house price developments and the role of fundamentals
OECD Economic Outlook No 78, December 2005

The current house price boom is strikingly out of step with the business cycle, contrary to the traditional explanations.

The article points to local factors: “House prices can…be affected by….features that are particular to [a] market. Of note are restrictions on the availability of land for residential housing development that can constrain the responsiveness of supply.” It pinpoints zoning regulations, demographic developments, and financial deregulation in mortgage markets as key factors.

The determinants of house prices in Central and Eastern Europe
Balázs Égert and Dubravko Mihaljek, BIS Working Papers, September 2007-10-21

In eight transition economies of Central and Eastern Europe (CEE), house prices are determined largely by economic fundamentals, according to this study. There are also some transition-specific factors, in particular the development of housing market institutions, and of housing finance products.