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Consumption, household's welfare, and dynamics or property prices

Final Activity Report Summary - PROPERTY PRICES (Consumption, household's welfare, and dynamics or property prices)

The original research proposal was motivated by rapidly rising real estate prices around the world, including countries such as Britain, Sweden, and the United States. Elevated house prices raise the question of whether there is a housing market bubble. Answering this question matters since a collapsing bubble can adversely affect economic performance, which may have been already happening because of the currently cooling U.S. real estate market. However, identification of a bubble is a rather complex issue.

To determine whether a current house price level is too high one has to define the fundamental value of a house. This is the area in which the present work adds to existing research. The conducted study did not simply compare aggregate time series for house prices and for fundamental variables such as rents or mortgage rates. It used data at the regional level which was possible due to recently devised statistical tests and due to data availability.

These tests enabled a formulation of a more precise bubble test and at the same time accounted for mutual dependence across regions. This test was applied to one of the biggest world real estate markets, the United States. The house price was compared to all potential demand and supply shifters available at the regional level. These included rents, personal income, population growth, stock market wealth, inflation, building costs, and mortgage rates. It was found that the prices did not in fact correspond to fundamentals during the last three decades. The likelihood of a bubble occurrence in the United States was the highest in the late 1980s, the early 1990s and between 1998 and 2005.

The second important issue regarding housing prices is how their changes affect households. The house prices can either rise or decrease (perhaps even collapse) and hence affect consumption and well-being of households. The nature of this effect is the next subject of the conducted study. Three types of approach were used to analyse this effect. The first is an equilibrium model of the housing market with an explicit characterization of the consumer behaviour. It combines several features previously appearing in the literature but never used together before. Namely, it specifies both the supply and demand sides of the housing market in a dynamic context and accounts for financial constraints of households.

Based on this model, it is concluded that house price appreciation in the U.S. has been demand driven and therefore has increased the aggregate welfare in the economy. The second approach analyses the impact of real estate prices on consumers via a life-cycle model. The present study focused on the case of the Czech Republic. The Czech Republic is a former transition economy. Its housing market together with the market for mortgages started developing rapidly only a decade ago. It is therefore a natural experiment in progress.

At the same time, the analysis of sensitivity of the Czech households to attributes of the real estate environment is of importance for policy makers as well as for practitioners. The conducted research revealed that in an environment with rising house prices and a relatively high uncertainty regarding inflation and interest rates, the Czech households were better off using mortgages with a fixed interest rate as compared with adjustable-rate mortgages.

Finally, econometric analysis of micro-level data is the third approach to analyse effects of changing real estate prices. This research project used the Czech household budget survey data combined with regional data on house prices. It was found that higher apartment prices increased consumption for owners and higher rents reduced consumption for renters.