European House Price Volatility and the Macroeconomy: The Implications for European Monetary Union

This paper addresses the neglected question of the implications for European economic and monetary union of divergent European housing market institutions and financing. Evidence is reviewed which suggests that there is little significant convergence in European housing finance systems and their regulation. Consequently real house prices display differing degrees of volatility and cyclicality across Europe with only weak evidence that there is a common cycle across different countries. Econometric analysis finds little evidence for any substantial convergence in real house prices, with a marked difference apparent between “core” European economies such as Germany, Italy and the Netherlands and countries such as the UK and Finland where owner-occupation rates are high, housing finance systems deregulated and real house prices volatile. This difference is also found to be apparent in the degree of association between real interest rates and real house prices, with stronger causal links evident for the latter type of economy. The importance of real house price movements for the
macroeconomy is to be found in their impact, working through conjectured effects on permanent income expectations, on consumer spending activity. Once again it is countries such as the UK and Finland where the causal links appear strongest. This implies that the adoption of a single European monetary policy is likely to lead to inflationary pressures in countries with higher owner-occupation rates, leading to a need for corrective fiscal action or the re-introduction of more stringent forms of personal sector financial and housing finance regulation.