House Prices, Fundamentals and Inflation

Abstract

This paper studies actual house prices relative to fundamental house prices. Using UK data and a time-varying present value approach, we find that deviations of house prices from their fundamental value (as warranted by real disposable income) are significant but not dominated by speculative activity; the driving force appears to be over-sensitivity to expectations about fundamentals. Our findings suggest that inflation (excluding house prices) responds asymmetrically with more impact on future inflation from turning points at peaks of overvaluation compared to turning points at troughs of undervaluation; and the turning points appear to have independent forecasting ability for inflation. This suggests that house prices have information about inflation which could be exploited by the Monetary Policy Committee (MPC).