This paper develops a new approach to the determination of house prices, with housing demand being conditioned directly on consumers' expenditure rather than the determinants of expenditure. We obtain estimates of the long-run demand for housing condition which relates the marginal rate of substitution between the consumption of housing services and the consumption of goods to the real user cost of housing. House prices are assumed to adjust so as to clear the housing market. Conditioning on consumption ensures that the permanent income measure used in determining the level of consumption is consistently reflected in housing demand, so that consumption of goods and housing services cannot diverge indefinitely. It also ensures that the effects of financial liberalisation on the relative consumption of housing and non-housing goods and services can be estimated separately from its common influence on their level. These effects are captured using the average loan-value ratio for first-time buyers.
Our model is tested on UK data from 1968 to 1994. The proposed model is found to have structurally stable parameters across both the housing boom of the late 1980s and the recent housing market downturn. Statistical comparisons with the more conventional models in use at HM Treasury and the Bank of England during the early 1990s provide additional evidence in favour of our proposed approach.