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Wednesday, 13th June 2007

Why Do House Prices Fall? Perspectives on the Historical Drivers of Large Nominal House Price Declines

Why Do House Prices Fall? Perspectives on the Historical Drivers of Large Nominal House Price Declines (PDF; 657 KB)
Source: Harvard University Joint Center for Housing Studies

The primary finding of this paper is that the presence and magnitude of job loss and the presence and magnitude of overbuilding, as measured by a relatively simple proxy, are the crucial determinants of both the probability that a place will experience a price decline and the magnitude of the decline. Interest rates appear to play a relatively minor direct role, though they may play an important indirect role. First, they can be important contributors to economic slowdowns and recessions that slow or turn job growth negative. Second, rising interest rates, by making housing more unaffordable, can slow price appreciation and thereby abruptly reduce speculative demand and the demand for primary and second homes that may have contributed to overbuilding. While there does appear to be a relationship between how much prices go up and whether and by how much they fall, the relationship does not hold in many cases and is difficult to disentangle from the job losses and overbuilding that often occur at about the same time. For example, overheated house prices can contribute to overbuilding by sparking speculative activity and pulling forward primary and second home demand. In addition, overheating is a less robust predictor of elevated price decline probability and magnitude than overbuilding and net job loss.



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