Mortgage borrowing and the boom-bust cycle in consumption and residential investment

Abstract

This paper studies the transmission of the major shocks in the U.S. housing market in the 2000s to consumption and residential investment. Using geographically disaggregated data, I show that residential investment is more responsive to these shocks than consumption, as measured by elasticities and the implied contributions to GDP growth. I develop a structural life-cycle model featuring multiple types of housing investment to understand the large responses of residential investment. Consistent with the microdata, the model generates lumpy debt accumulation, lumpy housing investment and a strong correlation between mortgage borrowing and housing investment at the early stage of the life cycle. In the model, households move up the property ladder by increasing their mortgage debt after they have accumulated enough home equity. Since liquidity constraints and fixed costs prevent especially young homeowners from acquiring their desired home, shocks to their borrowing capacity have a large impact on residential investment.