Norges Bank has recently estimated a relation for house prices. The model contains effects of the housing stock, the unemployment rate, banks’ lending rates after tax, total wage income in the economy and an indicator of household expectations concerning their own financial situation and the Norwegian economy. In the work on the relation, we did not find any evidence to suggest that migration or demographic conditions have strong direct effects on house prices. However, demographic changes may affect prices indirectly by affecting overall wage income in the economy. The estimated relation provides a good explanation of house price developments in recent years. High wage income has pushed up house prices. The contribution from interest rate changes has also been high in the last two years but has diminished somewhat recently. In the model, interest rate changes have a strong short-term effect. House prices in Norway have risen substantially since 1995. House prices have also risen rapidly in many other countries. The IMF has expressed concern that house prices may be too high in relation to fundamentals in some countries. In Norway, there have been signs recently of a slower rise in house prices. The seasonally adjusted, monthly rise has been low since November 2004, but it edged up again in April. On the other hand, the time it takes to sell a dwelling has declined further, whereas the number of dwellings sold remains high. Housing starts increased substantially in 2004 as a result of high house prices, low interest rates and a favourable economic outlook.

At the same time, higher asset prices provide scope for raising larger secured loans. When negative news appears and spreads, investments do not match expectations and the sentiment is reversed, asset prices fall. Banks’ security is reduced. Borrowers experience problems in servicing their debt. Demand and income developments are weakened and banks’ losses increase. The sharp rise in house prices and household debt has increased the interest in the interplay between monetary policy and the stability of the financial system. Financial stability and price stability are mutually reinforcing. Financial stability facilitates a stable supply of credit and stable capital flows and underpins the transmission mechanisms for monetary policy. Price stability strengthens financial stability. Low and stable inflation provides households and enterprises with a clear indication of changes in relative prices. This makes it easier for economic agents to make the right decisions and leads to greater price stability in financial and property markets than would otherwise be the case. Developments in credit and asset prices have an influence on inflation. We take this into account in our interest-rate setting. We are also aware of the potential risks to financial stability. The current low interest rates make it easy to service debt. The household interest burden, i.e. interest expenses after tax in relation to the sum of interest expenses and disposable income, is low despite strong growth in debt. The interest burden will increase, however, when the interest rate reaches a more normal level. Only 14 per cent of household loans are fixed-interest loans.