Academic journal article Economic Perspectives

The Great Turn-of-the-Century Housing Boom

Academic journal article Economic Perspectives

The Great Turn-of-the-Century Housing Boom

Article excerpt

Introduction and summary

In the last ten years, residential investment as a share of gross domestic product (GDP) has reached levels not seen since the 1950s. At the same time, the homeownership rate has climbed to levels never before achieved. This article discusses the forces underlying these developments and argues that they are connected.

Figure 1 shows the ratio of nominal residential investment to GDP from 1947 to 2005, with shaded regions indicating years in which the economy was in recession. The spending share of residential investment is clearly highly cyclical, but in the last ten years it has seemed relatively immune to macroeconomic disturbances. Indeed, from a near historic low below 3.5 percent in 1991, residential investment spending has grown rapidly, passing 6 percent of nominal GDP in 2005.

Figure 2 shows the history of the homeownership rate from 1890 to 2004. The homeownership rate equals the number of owner-occupied housing units divided by the number of occupied housing units. Between 1890 and 1940, the homeownership rate varied between 43 percent and 48 percent. After World War II, the homeownership rate rose rapidly, and by the mid-1960s it had surpassed 64 percent. Upward progress in homeownership stalled in the 1970s and even fell in the 1980s. It began growing again in the mid-1990s and by 2005 had reached a new high of 69 percent.

Understanding why residential investment and homeownership have reached such unusually high levels is useful from a policymaking standpoint. For example, monetary policy has been traditionally viewed as having a strong influence over new home construction. Have the high levels of residential investment been driven by unusually loose monetary policy? Another concern of policymakers is that the unusually high level of spending on new housing reflects speculation and is not driven by underlying fundamentals. The increase of rates of homeownership has long been an announced goal of policymakers. Indeed, both Presidents Clinton and George W. Bush have touted the rising levels of homeownership as accomplishments of their administrations. So, understanding why homeownership rates have risen should help in the development of policies directed at establishing socially and economically desirable levels of homeownership.

Much has been said in the press about high levels of house prices and the possibility of a house price bubble. Figure 3 displays the median sales price of existing single family homes, converted into real terms by dividing total sales price by the Consumer Price Index (CPI) for all urban consumers. This figure shows that indeed the real price of single-family homes, after being roughly stable from the early 1980s to the mid-1990s has grown considerably since. This article does not address house prices directly. Rather, it seeks to understand recent developments by focusing on quantities. To the extent that the quantities can be understood by considering the underlying economic fundamentals, such as productivity growth and the evolution of the mortgage market, then the recent growth in house prices is probably not due to excessive speculation in the housing market, such as occurs in a bubble. We argue that our findings point toward the high prices being driven by fundamentals.

The article begins by describing the evolution of key variables that should influence residential investment. While informative, this discussion has the drawback that it is difficult to distinguish the truly exogenous factors driving the spending. For example, showing that real interest rates have been relatively low as residential investment has surged beyond its trend level does not establish that unusually loose monetary policy is to blame. Consequently, the next phase of the analysis involves an econometric study of the effects of identified exogenous shocks to the economy. This study focuses on the roles of technological change and monetary policy. …

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