Across North America and much of Europe, countries have experienced record highs in house price to income ratios. To what extent have common factors driven this trend? A new paper by Kieran McQuinn and Gerard O'Reilly at the Central Bank of Ireland proposes A Model of Cross-Country House Prices. The authors find that despite substantial national differences, capacity to borrow - as reflected by income and interest rates - has been a common driver of house price increases:
In this paper we propose that a cross-country house price demand schedule can be adequately represented by a price suggested by the average amount that can be borrowed in each country with the latter being determined by current disposable income levels and interest rates.
Rising incomes and low interest rates have fuelled the housing boom:
The model is applied to a panel of 16 OECD countries from 1980 to 2005 using both single country-by-country and panel econometric approaches. Our results support the existence of a long-run relationship between actual house prices and the amount individuals can borrow and we find plausible and statistically significant adjustment, across countries, to this long run equilibrium.
A nice piece of work, on which others can build.