Identifying the Erratic Phase in the Behavior of the US Housing Prices

In this paper, we have provided empirical evidence on the presence of two distinct regimes for the evolution of the US housing price inflation. We apply a twostate Markov switching model to estimate the regimespecific behavior of the housing price inflation and the probabilities that the US economy is in respective regime. One of the two regimes appears ‘typical’, in that the rate of housing price inflation negatively responds to higher real interest rate and that the effect of a shock to the housing inflation dies out in a reasonable period of time. The other regime, however, is ‘atypical’, in that the housing price inflation is positively related with real interest rate and that any disturbance to the housing price inflation lingers for almost two years. Data features of the atypical regime suggest that such a regime is a mixture of the formation and collapsing of housing price bubbles. It is also shown that, depending on which state the economy is in, the appropriate policy responses of the central bank are qualitatively different.