House Prices and Productivity
Monday, July 13, 2009 at 09:09 AM EDT
Many economists, myself included, refer to the recent boom and bust in house
prices as a bubble, whose foundation lay in a combination of credit market
excesses and human imperfections. Fundamentals certainly played a role as well,
but bubble forces were particularly important.
In a short paper
recently published by the New York Federal Reserve, Jim Kahn makes a very
different argument: that the boom and bust in house prices can largely be
explained by a boom and bust in productivity growth:
The housing boom and bust of the last decade, often attributed
to â€œbubblesâ€ and credit market irregularities, may owe much to
shifts in economic fundamentals. A resurgence in productivity that began in the
mid-1990s contributed to a sense of optimism about future income that likely
encouraged many consumers to pay high prices for housing. The optimism
continued until 2007, when accumulating evidence of a slowdown in productivity
helped dash expectations of further income growth and stifle the boom in
residential real estate.
Jimâ€™s argument depends on several related lines of reasoning:
- First, he notes that productivity drives long-term income growth and that
incomes determine how much families can pay for homes. He then argues that the
demand and supply for housing are inelastic and, as a result, rising incomes
imply rising house prices. Putting these pieces together, he concludes that
faster productivity growth implies faster house price appreciation.
- Second, he notes that productivity growth accelerated in the mid-to-late
1990s and then slowed around 2004. The productivity acceleration thus began
shortly before house price took off, and the productivity slowdown began
shortly before house prices began to collapse.
shows his estimate of whether the United States is in a
high-productivity-growth regime over time. That probability was essentially
zero in the early 1990s but jumped to 100% by the late 1990s. It then fell
close to zero again in the mid-2000s.
- Third, Jim argues that it takes time for people to recognize that a
productivity shift has occurred. Although the recent productivity slowdown
began, according to his estimates, in 2004, observers wouldnâ€™t recognize
that for some time. His model suggests, in fact, that observers wouldnâ€™t
have been able to figure out that productivity had slowed until the release of
revised data in the summer of 2007. Forecasts before then (see the blue line
labeled June 2007) would likely have continued to presume solid productivity
growth. But subsequent forecasts (the orange line labeled August 2007) would
have assumed lower productivity growth.
In his view, that recognition lag explains why house prices continued to
grow rapidly for a few years after the productivity slow down began. In short,
where many observers see bubble-like thinking, he sees a time lag in
understanding the state of the economy.
P.S. Jimâ€™s paper also provides some interesting projections of
productivity growth. The following graph, for example, shows the difference
between projections that assume the U.S. is in a high-productivity-growth
regime (blue line from June 2007) and projections that assume we are in a
low-productivity-growth regime (orange and green):
This article originally appeared on Donald Marron.