The dynamics of the house price‐to‐income ratio: Theory and evidence

The house price‐to‐income ratio (PIR) is widely used as an affordability indicator. This paper complements the cross‐sectionally focused literature by proposing a tractable model for the PIR dynamics. Our model predicts that the PIR is very persistent and is correlated to the lagged aggregate output. Cross‐country analysis confirms this prediction and provides evidence for a long‐term, positive, and significant relationship between PIR and aggregate production. Our results hint at the construction of an early warning system for housing market mispricing. Our tractable formulation of a stochastic money growth rule may carry independent research interest.