Government expenditure and the housing puzzle: Unpacking mechanisms

Javier Ferri and Francisca Herranz-Baez

Economic Modelling, 2024, vol. 140, issue C

Abstract: Shocks in housing demand can trigger economic downturns, prompting governments to boost public consumption to mitigate its impact. The literature has found conflicting effects of government spending on residential investment and housing prices. We hypothesize that differences in the construction sector’s responses may be due to factors unaccounted for in the estimations, such as labor supply response to wage changes, labor reallocation between sectors, and the amount of household debt. Using a dynamic general equilibrium model, we demonstrate that government consumption boosts tradable goods production, resulting in increased labor demand and wages. However, this diverts workers away from construction, potentially deepening the wound in this sector. Specific labor market attributes and economic indebtedness can catalyze worker displacement from the construction sector, thus adversely affecting residential investment and overall credit. As a result, borrowers face considerable welfare losses. Redirecting government spending toward housing sustains residential activity while exacerbating the overall welfare decline. Our analysis provides plausible explanations for the disparate empirical evidence on the impact of government spending on the construction sector.

Keywords: Fiscal policy; Housing shock; Labor reallocation; Two-sector dynamic general equilibrium model; Credit-constrained households (search for similar items in EconPapers)
JEL-codes: E24 E44 E64 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0264999324002013
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:140:y:2024:i:c:s0264999324002013

DOI: 10.1016/j.econmod.2024.106844

Access Statistics for this article

Economic Modelling is currently edited by S. Hall and P. Pauly

More articles in Economic Modelling from Elsevier
Bibliographic data for series maintained by Catherine Liu ().