Three rooftops and blue skies

Can you briefly summarize what your paper is about?

In the paper, we have two goals: 1) we’re trying to understand what caused the boom and bust in house prices in the 2000s in the United States and 2) why did the movement in house prices lead to a collapse in consumption (and ultimately contribute to the Great Recession)? To answer those questions we write down a rich structural model of the economy and housing markets that encapsulates the leading explanations for the rise and subsequent fall in house prices in the US, namely the credit conditions view and the expectations view. The credit conditions view argues that it was a relaxation in credit supply to marginal borrowers the drove the boom and subsequent bust, whereas the expectations view argues that it was households’ beliefs about future house price growth that drove house price dynamics. Using our structural model estimated to match time-series, cross-sectional and life-cycle data over this time period, we find that credit relaxation cannot explain the boom and bust and house prices (though, was important for home ownership, leverage and foreclosure dynamics) and thus come down on the side of the expectations view. Further, we find that the transmission between house prices and consumption was driven mainly by wealth effects.

How do you think your paper will influence future research on the topic?

Our paper presents a benchmark framework for understanding the causes and consequences of housing cycles and a definitive answer for the causes of the recent episode in the United States. We anticipate that our paper will shift the focus on the literature from being solely focused on the credit channel to devoting more research, both empirically and theoretically on understanding house price expectation formation.

Where did the idea for this paper originate from?

We wanted to understand the massive decline in employment during the Great Recession and in particular the common view that this decline was in part, if not entirely, due to a fall in aggregate demand, i.e. a fall in consumption driven by the fall in house prices. We realized that to really answer the question we needed to understand what it was that moved house prices to begin with, to rule out that it was some other common factor that had driven both the consumption and house price dynamics.

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