Bubble, Bubble – Is there House Price Trouble--in Canada?

Abstract

Canadian and U.S. real estate markets have compared similarly along dimensions such as inflation, mortgage interest rates, population and income growth and other measures. With respect to house prices, however, the series have moved in similar ways at some times, but then significantly diverged by the second quarter of 2007. For example, Canadian and U.S. house price indices reached essentially identical levels in 1987Q2, 1995Q1 and 2007Q2. As a consequence of the U.S. financial crisis and precipitous decline in house prices, the U.S. and Canadian indices have sharply diverged. Our paper examines whether or not the house price indices were driven by fundamentals during these time periods, or whether they diverged from fundamentals. We find that the U.S. house prices closely aligned with fundamentals until the mortgage markets crashed in 2008. We find that Canadian house prices continue to align with fundamentals. However, there have been some significant market changes between the two countries and key housing market measures indicate that Canadian markets are now moving along some paths similar to those taken by the U.S. prior to the crash.