Supply Constraints Are Not Valid Instrumental Variables for Home Prices Because They Are Correlated with Many Demand Factors
31 Pages Posted: 25 Feb 2014 Last revised: 30 May 2015
Date Written: May 28, 2015
Economists sometimes assume that strictly regulated housing markets near mountains and oceans are expensive because they are costly places to build, not because they are nice places with productive firms and workers. U.S. data show this convenient assumption to be false. Housing supply has grown more in supply-constrained markets than elsewhere over recent decades, indicating constraints are correlated with demand growth. Supply constraints are highly correlated with productivity proxies such as historical education levels, immigration, and national employment growth in locally prevalent industries. The correlation between constraints and productivity growth invalidates common uses of constraints as part of instrumental variables for home prices. The relationship between supply constraints and price volatility is much weaker after accounting for observable demand factors.
Keywords: Housing Demand, Financing Policy, Wage Level and Structure
JEL Classification: R21, G32, J31
Suggested Citation: Suggested Citation