Dynamism Diminished: The Role of Housing Markets and Credit Conditions

Abstract

The Great Recession and its aftermath saw the worst relative performance of young firms in at least 35 years. More broadly, as we show, young-firm activity shares move strongly with local economic conditions and local house price growth. In this light, we assess the effects of housing prices and credit supply on young-firm activity. Our panel IV estimation on MSA-level data yields large effects of local house price changes on local young-firm employment growth and employment shares and a separate, smaller role for locally exogenous shifts in bank lending supply. A novel test shows that house price effects work through wealth, liquidity and collateral effects on the propensity to start new firms and expand young ones. Aggregating local effects to the national level, housing market ups and downs play a major role – as transmission channel and driving force – in medium-run fluctuations in young-firm employment shares in recent decades. The great housing bust after 2006 largely drove the cyclical collapse of young-firm activity during the Great Recession, reinforced by a contraction in bank loan supply. As we also show, when the young-firm activity share falls (rises), local employment shifts strongly away from (towards) younger and less-educated workers.