What does the house price-to-income ratio tell us about the housing market affordability: A theory and international evidence

While the house price-to-income ratio (PIR) is widely used as an indicator for affordability even housing market mispricing, formal analysis is relatively rare. This paper proposes a simple dynamic, stochastic general... [ view full abstract ]

While the house price-to-income ratio (PIR) is widely used as an indicator for affordability even housing market mispricing, formal analysis is relatively rare. This paper proposes a simple dynamic, stochastic general equilibrium (DSGE) model and shows that the PIR is correlated to the previous periods aggregate output. The model also predicts that the variance of PIR is positively correlated with the variance of output. We confirm these predictions and provide evidence for a long term, positive and significant relationship between PIR and output with cross-country data. Our tractable formulation of a stochastic money growth rule may carry independent research interest.