In this paper we investigate house price misalignments and their effect on the real economy. We estimate the long-term relationship between house prices and the fundamentals that determine long-term house prices for a panel of European countries with dynamic OLS, using data from 2004–2018. We find that income has been the main driver of house prices based on fundamentals in all countries, while the supply of dwellings has calmed the rise in house prices in some countries. We calculate house price misalignments, which are deviations of house prices from the value based on fundamentals, and we employ them in the growth model. The results of the growth regression indicate that house price imbalances amplify business cycles in the short term, but in the long term house price overvaluations slow economic growth down. The findings imply that it is crucial to take measures to stabilise housing cycles.
JEL Codes: E21, E44, R21, R31, G01
Keywords: housing markets, fundamental house price, misalignments, imbalances, overvaluation, economic growth