The interaction of actual and fundamental house prices: A general model with an application to Sweden

The paper presents a general method for estimating a country’s level of fundamental house prices and its interaction with actual house prices. We set up a unified empirical model which can be used to analyze the time-series behavior of the fundamental house price and to test various hypotheses regarding its relation to the actual house price. Conditional forecasts from the model allow us to simulate policy experiments. To illustrate how the methods work, we apply it to data for Sweden. We find a tendency for actual house prices to converge on fundamental prices, albeit rather slowly. To achieve a significant fall in actual house prices it is necessary to increase the user cost substantially. •Estimation of fundamental house prices in Sweden.•Sources of fluctuations in actual and fundamental house prices.•Simulating policy-induced shocks to the housing market.