Implications of intertemporal optimization for house and land prices

The Euler equation is used for the intertemporal allocation of durable good s in conjunction with a simple model of housing flow supply to derive impli cations for the relation between house and land prices. Data from England a nd Wales fails a key time series test in this respect. The rejection of the theory is shown to be mainly due to the specification of the housebuilding industry: perfect competition makes house prices cointegrated with land pr ices and housebuilding costs. There is also evidence that borrowing constra ints impair the validity of the representative-agent framework for the hous ing sector.