Is Your Bubble About to Burst?

Abstract

House prices have risen quite sharply since 2000. Coming on the heels of a stock market crash, many analysts have raised the specter of collapse in house prices and have conjured up dire consequences from such a collapse. This article examines the extent of the house price rise, whether there are factors that account for it, whether prices are likely to collapse, and if they did, the macroeconomic consequences of such a decline. It suggests that the rise in prices was due to fundamental economic changes, especially a decline in real interest rates. A sharp decline in the national average price is unprecedented, but national prices have declined slowly relative to other goods and services, not by falling, but rather by failing to rise as rapidly as other prices. This has happened twice in the last twenty-five years and is likely to be the pattern in coming years, if prices return to some past average relationship. Finally the article discusses the economic consequences of a house price collapse and argues that the recessionary implications of a price bust would be minimal. There are three main potential channels of influence, a banking sector crisis due to mortgage defaults, a decline in consumer spending as households attempt to rebuild wealth, and a decline in home building in response to diminished sales. The article argues that none of these possibilities are likely, even in the unlikely event of a major price collapse.