Housing Prices May Become
More Volatile, Fed Report Says
By BRIAN BLACKSTONE
August 23, 2006
WASHINGTON -- The rise in housing prices over the past decade "owes significantly" to falling inflation-adjusted interest rates and changes in the mix between rates and the "housing premium," which could mean more volatile home prices in coming years, according to a paper written by Federal Reserve economists.
"If the break we observed in 1997 proves to be permanent, we should expect housing prices to be much more volatile in the future," Fed economists Sean Campbell, Joshua Gallin, Robert Martin and former Fed economist Morris Davis wrote in a paper.
The paper, dated April, was posted on the Fed's Web site Monday.
The economists studied ratios between housing rents and prices between 1975 and 1996 and between 1997 and 2005, the latter period being characterized as the recent housing boom. They used three components -- future rent growth, real interest rates and the "housing premium," which is the return to housing investments over and above the yield of the 10-year Treasury note.
Similar methods have been used by economists to study stock and bond values. In the 1975 to 1996 period, interest rates and the housing premium offset each other, but after 1997 "this negative correlation appears to have disappeared," the authors stated.
"A substantial portion of the increase in prices relative to rents can be attributed to falling real rates, and an even more substantial portion...can be attributed to a decline in the housing premium," the authors said, calling their results "a novel way to characterize the recent housing boom."
The authors said one of the "major contributions" of their research is that it allows the housing premium to vary over time and location, rather than holding it fixed as other studies have done.
The research "implies that the expected future real return to housing is the primary determinant of the trend and variance of rent-price ratios," the authors wrote. "In this way, the housing market is remarkably similar to the stock and bond markets."
The behavior of housing prices is key to the economic and interest-rate outlook, and to the extent there's more volatility, it could make it tougher for the Fed to forecast housing's impact on the economy, said Brian Bethune, economist at Global Insight.
"It's always a challenge because when you look at household balance sheets, housing is huge," Mr. Bethune said. Therefore, "if we did see more volatility (in home prices), it would make forecasting more difficult."
Fed Chairman Ben Bernanke said in congressional testimony last month that "home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the nation as a whole, though significantly less rapidly than before."
That moderation means less of a boost to consumer spending, he added. The Fed expects a slowdown in demand to help limit price pressures in coming months, a forecast that formed the basis of its decision this month to pause its two-year rate-raising campaign with the Fed funds rate at 5.25%.
More Volatile, Fed Report Says
By BRIAN BLACKSTONE
August 23, 2006
WASHINGTON -- The rise in housing prices over the past decade "owes significantly" to falling inflation-adjusted interest rates and changes in the mix between rates and the "housing premium," which could mean more volatile home prices in coming years, according to a paper written by Federal Reserve economists.
"If the break we observed in 1997 proves to be permanent, we should expect housing prices to be much more volatile in the future," Fed economists Sean Campbell, Joshua Gallin, Robert Martin and former Fed economist Morris Davis wrote in a paper.
The paper, dated April, was posted on the Fed's Web site Monday.
The economists studied ratios between housing rents and prices between 1975 and 1996 and between 1997 and 2005, the latter period being characterized as the recent housing boom. They used three components -- future rent growth, real interest rates and the "housing premium," which is the return to housing investments over and above the yield of the 10-year Treasury note.
Similar methods have been used by economists to study stock and bond values. In the 1975 to 1996 period, interest rates and the housing premium offset each other, but after 1997 "this negative correlation appears to have disappeared," the authors stated.
"A substantial portion of the increase in prices relative to rents can be attributed to falling real rates, and an even more substantial portion...can be attributed to a decline in the housing premium," the authors said, calling their results "a novel way to characterize the recent housing boom."
The authors said one of the "major contributions" of their research is that it allows the housing premium to vary over time and location, rather than holding it fixed as other studies have done.
The research "implies that the expected future real return to housing is the primary determinant of the trend and variance of rent-price ratios," the authors wrote. "In this way, the housing market is remarkably similar to the stock and bond markets."
The behavior of housing prices is key to the economic and interest-rate outlook, and to the extent there's more volatility, it could make it tougher for the Fed to forecast housing's impact on the economy, said Brian Bethune, economist at Global Insight.
"It's always a challenge because when you look at household balance sheets, housing is huge," Mr. Bethune said. Therefore, "if we did see more volatility (in home prices), it would make forecasting more difficult."
Fed Chairman Ben Bernanke said in congressional testimony last month that "home prices, which have climbed at double-digit rates in recent years, still appear to be rising for the nation as a whole, though significantly less rapidly than before."
That moderation means less of a boost to consumer spending, he added. The Fed expects a slowdown in demand to help limit price pressures in coming months, a forecast that formed the basis of its decision this month to pause its two-year rate-raising campaign with the Fed funds rate at 5.25%.
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