Financial Cycles and the Real Economy
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Financial Cycles and the Real Economy

Lessons for CESEE Countries

Edited by Ewald Nowotny, Doris Ritzberger-Grünwald and Peter Backé

What is the link between the financial cycle - financial booms, followed by busts - and the real economy? What is the direction of this link and how salient is this connection? This unique book examines these fundamental questions and offers a paramount contribution to the debate surrounding the recent financial and economic crisis.
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Chapter 9: Do we understand what drives house prices?

Dubravko Mihaljek and Agne Subelyte


Housing markets have played a key role in macroeconomic and financial market developments in many European economies since 2000. Value added in construction and real-estate service sectors accounted for well over 15 per cent of gross domestic product (GDP) in some euro area countries before the financial and economic crisis that hit Europe in 2008. House price developments have influenced key economic decisions both during the pre-crisis boom and since the correction in housing markets started in 2008. Understanding house prices is therefore of critical importance for households, firms, financial institutions and policy-makers. But how well do we understand what drives house prices? This chapter describes how empirical economists approach the analysis of housing markets, and in particular how they try to detect the presence of bubbles in house prices. We discuss some intuitive explanations for the notion of house price bubbles, and present evidence on housing market developments in selected European countries since 2000. Our main conclusion is that we understand a great deal about the determinants of house prices, but not enough to be confident about detecting house price bubbles. The chapter is organised as follows. Section 9.2 describes the main approaches to the analysis of house prices. Section 9.3 discusses the concept of house price bubbles. Section 9.4 looks at the key data on house prices and their demand- and supply-side determinants. Section 9.5 concludes.

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