House price to income ratio and fundamentals: Evidence on long-horizon forecastability

This paper studies the relationship between the house price-to-income ratio (PIR) and economic fundamentals, and investigates the long-horizon forecastability of the PIR. We first construct a small DSGE model to derive a dynamic expression of PIR, linking PIRto macroeconomic fundamentals and the stance of monetary policy. Based on the theoretically derived PIR, variance decomposition suggests that interest rate and real income growth appear to be the main sources for the deviations of PIR. Using the difference between actual PIR and the estimated fundamental PIR as the predictor, we find that both in-sample and out-of-sample forecastability of the PIR over the future dynamics of PIR are significant.