Inferring Expectations from Observables: Evidence from the Housing Market

Abstract

We propose a new method to identify shifts in price expectations in the housing market through the accumulation of excess capacity. Expectations of future price increases (due to anticipated future demand for housing services) cause the current supply to increase, creating a temporary vacancy. We implement this intuition in a structural vector autoregression with sign restrictions and explore the effects of price expectations in the U.S. housing market. We find that price expectation shocks were a prime factor explaining the 1996–2006 boom, particularly in the Sand States. Expectation shocks at the boom’s peak reflected implausible growth expectations and reversed during the bust.