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Welfare Effects of Housing Price Appreciation in an Economy With Binding Credit Constraints

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  • Ashot Tsharakyan
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    Abstract

    This research analyzes the effects of recent housing price appreciation on aggregate welfare. It generalizes the results of Bajari et al (2005), who find that in a credit unconstrained economy with exogenous housing prices there is no effect of housing price appreciation on aggregate welfare. However, I demonstrate that if the households are credit-constrained and housing price is endogenous its appreciation implies a non-zero change in aggregate welfare. First, credit constraints are incorporated into Bajari et al’s model and it is shown that if they are binding housing price appreciation implies an improvement in aggregate welfare. I then construct a model where housing price appreciation is endogenous and is driven by demand and supplyside shocks. The supply shock results from a change in building permit cost. The demand shifts are generated based on dynamics of household income and interest rates. Both credit-constrained and unconstrained versions of this model are considered. Afterwards, using my theoretical results I calculate the aggregate welfare effects of housing price appreciation driven by the combination of demand-side and supply-side shocks observed in the US housing market from 1995 to 2004. The final result implies that housing price appreciation in 1995-2004 driven by the given combination of demand and supply-side shocks led to per household improvement of aggregate welfare by an amount equivalent to about 40% of mean household income in 2004.

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    Bibliographic Info

    Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp333.

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    Date of creation: Jul 2007
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    Handle: RePEc:cer:papers:wp333

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    Keywords: Housing price appreciation; aggregate welfare; binding credit constraints; endogenous housing price; demand and supply side shocks; median household income.;

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