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The Role of House Prices in Regional Inflation Disparities

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Theoretically, house prices will reveal greater disparities between regions than prices for more easily tradable goods and services. This contributes to regional disparities in inflation. In this report the author reviews a range of factors that are likely to cause greater disparities in house price inflation than in the price inflation of other goods and services. Two models are developed and estimated using Canadian data.

Since disparities in house price inflation can arise from regional shocks, the first model that is developed characterizes regional house prices as having an equilibrium relationship with the national consumer price index (CPI) in the long run, being influenced in the short run by such shocks as region-specific movements in real commodity prices, real capital spending and real current government expenditures.

Initial tests for cointegration support the hypothesis of a long-run relationship between house price levels and the level of the national CPI. While overall the estimation results suggest that regional house price movements are influenced by regional shocks, no generalizations across the regions can be made that indicate which shock variables are important.

Finally, the second model pooling cross-section and time-series observations is estimated to test the relative significance of the national and region-specific elements of variations in house prices. Both elements prove to be significant.