The Peculiar Economics of Housing Bubbles

8 Pages Posted: 25 Jun 2011  

Omer Bayar

University of Tennessee, Knoxville - College of Business Administration - Department of Economics

William S. Neilson

University of Tennessee, Knoxville - College of Business Administration - Department of Economics

Date Written: July 2011

Abstract

Home values increase rapidly during housing bubbles generating large capital gains. High loan‐to‐value (LTV) mortgages secured by expected future home values are one way to take advantage of these capital gains. In this article, we use a simple partial equilibrium consumer theory model to explore the implications of high LTV borrowing. We find that sufficiently large expected house price growth leads to an upward‐sloping budget line when households can obtain high LTV mortgages. In this environment, the demand for housing fits neither the conventional theories of consumer goods nor that of investment goods. In fact, increases in the expected future price of housing may reduce current housing demand, whereas decreases in the effective (current) price may lead to households buying smaller homes. Moreover, high LTV loans reduce the effectiveness of monetary policy, but raise the volatility of aggregate demand. Tighter borrowing standards may help lower demand volatility at the expense of shrinking the economy.

JEL Classification: E21, R21, E52

Suggested Citation

Bayar, Omer and Neilson, William S., The Peculiar Economics of Housing Bubbles (July 2011). Contemporary Economic Policy, Vol. 29, Issue 3, pp. 374-381, 2011. Available at SSRN: https://ssrn.com/abstract=1871539 or http://dx.doi.org/10.1111/j.1465-7287.2010.00235.x

Omer Bayar (Contact Author)

University of Tennessee, Knoxville - College of Business Administration - Department of Economics ( email )

508 Stokely Management Center
Knoxville, TN 37996-0550
United States

William S. Neilson

University of Tennessee, Knoxville - College of Business Administration - Department of Economics ( email )

508 Stokely Management Center
Knoxville, TN 37996-0550
United States

HOME PAGE: http://web.utk.edu/~wneilson/

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