Cabinet minister Ed Balls said there had "definitely" been a house price bubble in the past two years.
The Children and Schools Secretary, a former Treasury minister and adviser, added that it was still unclear what the real value of homes was.
In a pre-recorded interview with the BBC Radio 4 Today programme, Mr Balls said people had learnt in the late 1980s and early 1990s that prices went down as well as up. But he said there was also supply-and-demand economics to be taken into account.
"There was a pretty strong view that we had a growing demand for housing in this country and a rising population, but we had much lower levels of house building than we've seen in previous generations in the private and the public sector," he said.
"Therefore, there was a pretty strong view, which may still in part be true, that the real level of house prices had gone up, because there was more demand and less supply. So we don't quite know where the equilibrium is going to end up in terms of house prices but clearly they have fallen sharply over the last year from those very heady heights."
His comments come after a year of declining house prices, triggered by the credit crunch and the drying up of affordable mortgages.
Gordon Brown has predicted that the housing market will bounce back quicker in the UK than in the US where, he argues, too many homes have been built. The Prime Minister has said that the problem in Britain is a shortage of mortgages rather than demand for homes.
Mr Balls, who was chief economic adviser at the Treasury when Mr Brown was Chancellor, said it was often difficult to identify the underlying trend.
But he added: "In the last couple of years there has definitely been a house price bubble. There is no doubt about that. But is the long-term level of house prices going to return to its average level of 10, 15, 20 years ago? Well I think that depends upon what the underlying balance of supply and demand is."
Mr Balls went on: "It's not always easy to work out the difference between the ups and downs of the cycle and where the underlying trend is."
