Working Paper: NBER ID: w31862
Authors: Lars E.O. Svensson
Abstract: Appropriate indicators of housing valuation are important for macroprudential policy and assessments of risks to financial stability. Overvalued housing may result in a correction and a fall in house prices. This would weaken households’ balance sheets, reduce the collateral of mortgages and covered housing bonds, and could threaten financial stability. \nAccording to ECB (2023) and European Systemic Risk Board (2022), Swedish owner-occupied housing (OOH) was overvalued by about 55% in 2021q2, the largest overvaluation in the EU and EEA; according to European Commission (2023c), by about 30% in 2022. These assessments affect warnings and recommendations issued for Swedish economic policy and the shocks in EBA stress tests of Swedish banks. \nBut these large overvaluation assessments are due to the use of misleading indicators: the deviations of price-to-income (PTI) and price-to-rent ratios from their historical averages. They disregard mortgage rates and other housing costs and lack scientific support. According to a large housing literature, it is not the purchase price but the user cost that is the appropriate measure of the cost of living in OOH, the cost of the housing services that the OOH delivers. \nFrom this point of view, “Are house prices too high?” is the wrong question. The right question is, “Are user costs too high?” \nNew improved estimates of the user costs are constructed, including an adjustment for a preference shift during the coronavirus crisis in favor of larger and better housing. According to the user-cost-to-income (UCTI) ratio, Swedish owner-occupied houses have since 2010 instead become increasingly undervalued (not overvalued), by about 35% in 2019q4. Due to higher mortgage rates, they are less undervalued in 2023q4, but still about 25%. \nFor Sweden, the UCTI and PTI indicators are in fact strongly negatively correlated, with opposite signs. If the UCTI indicator is the right one, the PTI indicator is consistently wrong. \nThe valuation assessments of the ECB, the ESRB, the Commission, the OECD, and the IMF are scrutinized and compared. The problem of misleading indicators and overvaluation assessments—and resulting distorted warnings and recommendations—is not restricted to Sweden but concerns several other countries in the European Union.
Keywords: No keywords provided
JEL Codes: E43; G21; G50; R21; R30; R31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| PTI (F13) | overvaluation assessments (H25) |
| UCTI (L96) | undervaluation assessments (D46) |
| PTI and UCTI are strongly negatively correlated (C12) | overvaluation assessments based on PTI are misleading (H25) |
| reliance on PTI (F13) | flawed assessments by international organizations (F53) |
| reliance on UCTI (L96) | accurate housing valuation (R31) |