The Predictive Relationship between Swedish House Prices and Consumer Price Inflation

Abstract: Sweden has in the past three decades experienced low rates of inflation, rising house prices and a declining policy rate. This implicates that the households can increase debt due to expanding collateral, and thereby increase the sensitivity to higher interest rates. Existing literature suggests that higher house prices in combination with low interest rates should lead to higher inflation through the mechanisms known as the credit channel and wealth effects. The objective of this thesis is to investigate the relationship between house prices and consumer price inflation, and contribute to the risk assessment of future consumer price inflation. This thesis fills a gap in the existing literature of the relationship between house prices and consumer prices in the Swedish economy. The hypothesis is that house prices have a long-run positive relationship with consumer price inflation. In the empirical analysis a Vector Error Correction Model is estimated to examine if there exists a short- and long-run positive predictive relationship between the variables over the 1993–2020 period. The results show a long-run positive predictive relationship running from house prices to consumer prices, which indicate that both the credit channel and wealth effects have been present in the studied period. These findings imply that this relationship warrants attention in investment and policy rate decisions.