01 Feb 2006

Bubbles in Real Estate, A Longer-Term Comparative Analysis of Housing Prices in Europe and the US

Daniel Gros

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The spectacular growth of the US housing market as a driver of domestic demand has attracted a lot of attention over the last year. Policy-makers and market participants routinely add a health warning to their outlooks for the US economy related to the US housing market, based on the assumption that growth in US domestic demand will slow down dramatically once housing prices start to decelerate. It is generally assumed that the eurozone does not face a similar prospect, because areas of ‘froth’ (Spain, for example) co-exist alongside areas of declining prices (Germany). It would be wrong, however, to assume that housing prices in the euro area have on average behaved differently from those in the US.
This note presents a composite indicator for euro area housing prices and compares its evolution over the long run with that of the US. The main findings are quite simple:
1) The euro area aggregate index of real housing prices has risen almost as much as that of the US and is now (together with that of the US) about 40% above its 30-year average. This is almost exactly equal to the overvaluation of Japanese real estate at the height of the Japanese bubble, which was then followed by a decade of decline.
2) Over the last 30 years, the euro area index for real housing prices has tended to follow that of the US quite closely, but with a lag of about two years.
An ancillary finding is that the overvaluation (compared to a longer-term historical average) is even larger for the UK and Australia.