Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach

37 Pages Posted: 17 Jul 2015 Last revised: 10 Feb 2018

See all articles by Paolo Gelain

Paolo Gelain

Norges Bank

Kevin J. Lansing

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Gisle James James Natvik

BI Norwegian Business School - Department of Economics

Date Written: February 6, 2018

Abstract

We use a simple quantitative asset pricing model to "reverse-engineer" the sequences of stochastic shocks to housing demand and lending standards that are needed to exactly replicate the boom-bust patterns in U.S. household real estate value and mortgage debt over the period 1995 to 2012. Conditional on the observed paths for U.S. disposable income growth and the mortgage interest rate, we consider four different specifications of the model that vary according to the way that household expectations are formed (rational versus moving average forecast rules) and the maturity of the mortgage contract (one-period versus long-term). We find that the model with moving average forecast rules and long-term mortgage debt does best in plausibly matching the patterns observed in the data. Counterfactual simulations show that shifting lending standards (as measured by a loan-to-equity limit) were an important driver of the episode while movements in the mortgage interest rate were not. All models deliver rapid consumption growth during the boom, negative consumption growth during the Great Recession, and sluggish consumption growth during the recovery when households are deleveraging.

Keywords: Housing bubbles, Mortgage debt, Borrowing constraints, Lending standards, Macroprudential policy

JEL Classification: D84, E32, E44, G12, O40, R31

Suggested Citation

Gelain, Paolo and Lansing, Kevin J. and Natvik, Gisle James James, Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach (February 6, 2018). Norges Bank Working Paper 11 | 2014. Available at SSRN: https://ssrn.com/abstract=2631424 or http://dx.doi.org/10.2139/ssrn.2631424

Paolo Gelain

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

Kevin J. Lansing (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
PO Box 7702
San Francisco, CA 94105
United States
415-974-2393 (Phone)
415-977-4031 (Fax)

Gisle James James Natvik

BI Norwegian Business School - Department of Economics ( email )

Nydalsveien 37
Oslo, 0484
Norway

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