Housing markets are supposed to have a sharp relation with overall economy and are susceptible to business cycles (Meen 996). There has been a number of studies that have studied the correlation between housing and macroeconomic indicators. For example, studies have tried to find the relationship between labour market and housing and consumption (Bover, Muellbauer & Murphy 989), credit deregulation and housing decision (Miles 992), and developing macroeconomic models in order to capture the relation to housing decision in UK during 980s and 990s (Meen 996).
Ewinga & Wangb states, The housing market and the aggregate economic activity are linked. (2005, p. 87) Economics suggest that changes in real output of the economy may have an effect on housing starts. When the economy is in an expansionary mode, there will be more purchases of new homes while during recession, there will be a decrease in the purchase of normal goods like houses (Ewinga & Wangb 2005). When there is a rise in the aggregate price level, overall prices rise in the economy, making the purchase of goods and services costlier. If furniture, interior fixtures, etc. are considered to be complementary goods, then higher price level will lower the demand for houses also, thus putting downward pressure on residential housing star
ts.
Monetary policy too may have an effect on housing starts. Unexpected changes in monetary policy may have an effect on housing starts (Ewinga & Wangb 2005). If there is a tightening of the monetary policy will increase the cost of loans and therefore reduce demand for housing. However, theory suggests that the effect of expected monetary policy has a neutral effect on housing starts (Ewinga & Wangb 2005). Therefore, a higher interest rate will not reduce housing starts through Fisher effect as the real cost of acquiring loans may remain unaltered even after a rise in the price level.
Housing starts may have high effect from other macroeconomic indicators like GDP. A study conducted by Ortalo-Magne and Rady (999) shows that there in the UK and US, housing prices are more volatile than gross domestic product (GDP) and the former is less volatile than the number of transactions in housing markets. However, there is a specific correlation between the three variables. Therefore, it is believed that in the residential housing investments are more affected by the GDP change. Further, a positive relationship between rise of population and housing prices has been established (Jud & Winkler 2002). Further relation between changes in real income and housing demand also exists (Jud & Winkler 2002).