Financial Development and Housing Kuznets Curve

Abstract

We document a housing Kuznets curve in the data: Countries with the lowest and highest levels of financial development have relatively low house price-to-rent ratios, whereas countries falling in the middle range exhibit the highest housing prices relative to rents. We then rationalize this pattern through a model that incorporates occasionally binding borrowing constraints, where both capital and land can be used as collateral assets. Financial development allows the economy to transition from a constrained to an unconstrained steady state. During the transition, the price-to-rent ratio can rise above the levels in either of the steady states, providing an explanation for the observed housing Kuznets curve.

Keywords: Financial Frictions, Housing Bubbles, Housing Kuznets Curve, Financial Development JEL classification: E22, E44, E47, O16

JEL Classification: E22, E44, E47, O16