Sweden is experiencing double-digit housing price gains alongside rising household debt. A common interpretation is that mortgage lending boosted by expansionary monetary policy is driving up house prices. But theory suggests the value of housing collateral is also important for a household’s capacity to borrow. This paper examines the interactions between housing prices and household debt using a three-equation model, finding that household borrowing impacts housing prices in the short-run, but the price of housing is the main driver of the secular trend in household debt over the long run. Both housing prices and household debt are estimated to be moderately above their long-run equilibrium levels, but the adjustment toward equilibrium is not found to be rapid. Whereas low-interest rates have contributed to the recent surge in housing prices, growth in incomes and financial assets play a larger role. Policy experiments suggest that a gradual phasing out of mortgage interest deductibility is likely to have a manageable effect on housing prices and household debt.

The sustainability of double-digit house price gains and high household debt is a rising concern in Sweden. In common with other Nordic countries, Sweden experienced a boom-bust property cycle in the late 1980s and early 1990s in the wake of financial liberalization (Englund, 2015). Since then Swedish housing prices have broadly paralleled the rising trend in global housing prices (Sorensen, 2013). In contrast to many countries, Sweden experienced a relatively mild and short-lived house price decline during the global financial crisis (GFC), after which dwelling price increases started accelerating (Figure 1). In October 2015, house price gains reached 18 percent y/y led by apartment price rises in Stockholm and Gothenburg – the two largest cities – of over 20 percent. Figure 1 also suggests that household debt is reaching historic highs in real terms.