Determinants of the Home Price-Income Relationship : 1990-2011

Many studies have attributed the housing bubble or misalignment of home price and income to inefficient markets, irrational behavior, excessive leverage, financial innovations, macroeconomic imbalances, the Fed's easy money policy, and repeal of the Glass-Steagal Act. However, no study has actually looked at data for the past two decades to determine whether these factors do explain the movement in the home price relative to income in the United States. This study uses reduced form models to find the determinants of the income/home price ratio using data over the period 1990 to 2011. We find empirical support that lagged values of household debt and foreign indirect investment are significant predictors of movements in the income/home price ratio. Our results confirm that although the conventional mortgage rate has a stronger negative association with the income/home price ratio, the federal funds rate is a significant determinant as well. This supports the view that keeping the federal funds rate target too low for too long could prolong a misalignment between disposable income and home price. This study also identifies the inception of a housing bubble on a national scale by using the 20-year trend in a home affordability index as a benchmark