Bubbles or Fundamentals? Understanding Boom and Bust Episodes in the Housing Market

Rodolfo Manuelli, Adrian Peralta-Alva () and Carlos Garriga ()

No 937, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper we revisit the connection between changes in interest rates, loan-to-value ratios and expectations in inaÌ uencing housing prices. We construct a two good general equilibrium model in which housing is a composite good produced using structures and land. We show that changes in interest rates that are viewed as permanent have a large impact on house prices, while increases in LTV have smaller e§ects. We also show that if the model is to account for the actual boom and bust in house prices, it must be the case that households were exposed to multiple expectations shocks. Contrary to conventional wisdom, we show that the model can reconcile the disconnectness between house values and rents, addressing an open puzzle in the literature.

Date: 2012
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