A Longer-Term Comparative Analysis of Housing Prices in Europe and the U.S.
The main point of my latest paper on housing in the US and Europe is to document a remarkably close correlation between US and average euro area housing prices over the long run. This has not been widely noted beforehand because most observers have emphasized intra-euro area divergences (boom in Spain, slump in Germany). But it appears that the ongoing decline of prices in Germany has been more than compensated for by the boom in other parts of the euro area.
The stylized facts can be summarized as follows: There has been a tight correlation between US and euro area housing prices, with the latter following the former initially with a lag of about one to two years. More recently, the co-movement has become close to contemporaneous. On both sides of the Atlantic, prices (in real terms) have reached historical peaks and on both sides the upward movement had, until recently, accelerated. Since late 2006, prices seem to be declining in the US. The euro area data become available only much later. Hence it is not possible to determine whether housing prices have already turned on this side of the Atlantic as well. One key question for the ECB is now whether the usual pattern of (continental) Europe following the US will re-assert itself.
Given the sluggishness of housing prices, it seems likely that it will take some time before they actually decline on this side of the Atlantic as well. But it is also possible that the financial market turbulences caused by the US sub-prime lending sector will accelerate the ongoing slowdown of the housing sector in Europe.
My paper concentrates on the price/rent ratio as an indicator of overvaluation of housing since any change in the demand for housing (e.g. immigration) should be reflected in both prices and rents. However, over the last decade, the price/rent ratio has increased in parallel with the price of housing as rents have in general not increased by more than the overall consumer price index. This suggests that the current level of house prices does not simply reflect a higher demand for housing.
Should policy-makers be concerned about the behaviour of house prices? There is little evidence in the euro area of large-scale ‘sub-prime’ lending. But the evidence shown in Figure 7 suggests that house prices seem to have an important impact on domestic demand, with wide variations among individual countries.
In France and Italy, where house prices have increased almost as much as in the US, there is no evidence of a housing overhang. A downturn in housing prices might depress consumption somewhat, but not construction investment. By contrast, in Spain and Ireland, construction investment has increased to levels (18-20% of GDP) not seen in any other OECD country except Japan. In these two countries, lower housing prices are likely to be associated with a sharp and prolonged drop in domestic demand. Germany provides the mirror image to these two cases in that construction activity in Germany has now for some time been below average. All in all one can thus conclude that the coming downturn in housing prices should not have a strong impact on the eurozone average, but it is likely to lead to serious tensions within the area.