UK house prices and three decades of decline in the risk-free real interest rate

House prices have risen substantially faster than the prices of consumer goods in most G7 countries over the past few decades. This raises major policy issues: such rises affect the distribution of wealth within and between generations, the mobility of labour and financial stability. This paper explores why such rises have happened, and what the policy implications are. The price rises have been greatest in the United Kingdom, where real house prices have risen more than three and a half times since the 1970s, substantially outpacing real income growth. Meanwhile, rental yields have been trending downwards-particularly since the mid-90s. This paper reconciles these observations by analysing the contribution of a number of drivers of house prices. It shows that the rise in house prices relative to incomes between 1985 and 2018 in the United Kingdom can be more than accounted for by the substantial decline in real risk-free interest rates over the period. This is slightly offset by net increases in home-ownership costs from higher rates of tax. Changes in the risk-free real rate are likely to have been a major driver of changes in house prices. We analyse why they have driven house prices up faster in the United Kingdom than in other advanced economies. Our model predicts that a 1% sustained increase in index-linked gilt yields from current rates could ultimately result in a fall in real house prices of around 20%.