Conclusion
There has been much speculation in recent times concerning the rapid rise in Irish
house prices. Many commentators have suggested that current house prices are not
sustainable and that the recent rise in house prices reflect the presence of a
speculative bubble in the Irish house price series. However this study shows that
Irish house prices can indeed be modelled successfully using fundamentals alone.
This study uncovers a statistically significant structural break in the Irish house price
series in 1998 coinciding with the Irish government’s decision to reduce capital
gains tax from 40% to 20%. The structural break is seen as reflecting a change in
the Irish housing market as a far greater number of investors have been enticed into
the market by the government’s change in tax policy. The structural break is
modelled by the introduction of both a differential intercept term and a differential
house price elasticity of income term. The increase in the house price elasticity of
income from the first period to the second period is significant both from a statistical
and, more importantly, from an economic point of view.
Furthermore, the study suggests that, over the period of the study, the house price
elasticity of income is a time-varying parameter. The parameter is shown to be a
function of the volume of mortgage lending. Therefore this study suggests that a
reduction in liquidity constraints, reflected by an increase in bank lending, has
contributed significantly to the determination of Irish house prices over the period of
study.
33
In general, the overall fitted values of the final model match the actual Irish house
prices series extremely well. Population changes and changes to the housing stock
are significant determinants of Irish house prices. However, the expected real
mortgage rate is not a statistically significant explanatory variable. This latter
finding is consistent with other recent research work on house prices.
This study suggests that rather then simply dismissing the recent house price rises as
reflecting a speculative bubble in the housing market, the dramatic changes may be
explained by the fundamentals underpinning house prices. However there is a
danger that real house prices may fall considerably if government policy and/or
economic consideration force investors out of the housing market. Also real house
prices may fall if banks impose a credit squeeze with regard to mortgage lending.
Under such circumstances Irish house prices may experience the boom-bust scenario
so typical of many housing markets internationally.
) .