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Productivity and House Prices

In Bubble Poppers, I followed Peter Garber in arguing that claims about ‘bubbles’ in asset prices are a substitute for fundamental analysis, a non-explanation for events that people are otherwise unable or too lazy to explain.  In contrast to the dominant non-explanation for innovations in house prices in the United States, James Kahn argues that there is a strong relationship between house prices and productivity growth that explains the recent US housing boom and bust:

The housing boom and bust of the last decade, often attributed to “bubbles” and credit market irregularities, may owe much to shifts in economic fundamentals. A resurgence in productivity that began in the mid-1990s contributed to a sense of optimism about future income that likely encouraged many consumers to pay high prices for housing. The optimism continued until 2007, when accumulating evidence of a slowdown in productivity helped dash expectations of further income growth and stifle the boom in residential real estate.

posted on 09 July 2009 by skirchner in Economics, Financial Markets, House Prices

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The reason why their model does not work until around 1980 is because it is only after what are now called “Smart Growth” policies, including strong regulatory control over land use, kicks in in enough US jurisdictions to affect the national aggregates that they get the required effect.

The key relevant premise in their model is on page 3:
The fact that land, a finite resource, is a relatively large component of housing (compared with its “share” in other goods) makes the overall supply of housing relatively unresponsive to demand changes; the supply of houses cannot expand indefinitely to meet increases in demand.
Given how small the total land area devoted to housing is, that is not a “natural” feature of “land” but a regulatory artifact about land-for-housing.

This is where I demur on your “no such thing as bubbles” approach (though I entirely agree that they are no business of monetary policy deal with).  Assets operate as provides of services which generate income (monetary or notional).  As such, they also act as stores of wealth, since the income is generated (or is expected to be generated) over more than one time period.

If an expectation is generated about the value of an asset as a store of wealth that is not based on any future improvement in those services but entirely on expectations of an increase in the value of the asset as a store of wealth—that is, they are investing in the asset purely as a multiplier of wealth—then we have a bubble. People were investing in houses beyond their value as providers of housing services because of expectations about houses’ value as a multiplier of wealth. This was entirely created by regulatory restrictions building up an experience of ever increasing value in excess of inflation, even though that is not the long-term pattern of housing prices. And is not the pattern in, for example, Germany where the constitution incorporates a right to build.

Posted by Lorenzo  on  07/12  at  01:50 AM


If an expectation is generated about the value of an asset as a store of wealth that is not based on any future improvement in those services but entirely on expectations of an increase in the value of the asset as a store of wealth—that is, they are investing in the asset purely as a multiplier of wealth—then we have a bubble.

But isn’t the issue that there is no way of knowing beforehand whether the price of an asset is increasing because the value of the sevices it provides are (reasonably?) expected to rise or because it is becoming more attractive as a store of wealth. Indeed, what test could be devised to distinguish between these two motivations? If housing becomes relatively scarcer, for whatever reason - such as due to a combination of rising demand and restricted supply - one would expect to see prices rise in a well functioning market. This naturally means that prices are vulnerable to changes in regulations that allow an increase in supply, but that is always the case.

Posted by .(JavaScript must be enabled to view this email address)  on  07/12  at  12:48 PM


Would agree with Rajat that the distinction is hard to draw in practice and I’m not even sure if it is all that meaningful in theory. 

Supply-side rigidities are undoubtedly important.  In Germany’s case, demographics would also play a role in explaining flat house price growth.

Posted by skirchner  on  07/12  at  10:11 PM



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