Speculative housing markets and rent control: insights from nonlinear economic dynamics

Frank Westerhoff,Noemi Schmitt

doi:10.1007/s11403-020-00312-3

Frank Westerhoff, Noemi Schmitt

Open Access

https://doi.org/10.1007/s11403-020-00312-3

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Abstract

We propose a novel housing market model to explore the effectiveness of rent control. Our model reveals that the expectation formation and learning behavior of boundedly rational homebuyers, switching between extrapolative and regressive expectation rules subject to their past forecasting accuracy, may create endogenous housing market dynamics. We show that policymakers may use rent control to reduce the rent level, although such policies may have undesirable effects on the house price and the housing stock. However, we are also able to prove that well-designed rent control may help policymakers to stabilize housing market dynamics, even without creating housing market distortions.

Highlights

Galbraith (1994), Kindleberger and Aliber (2011) and Glaeser (2013) demonstrate that boom–bust housing market dynamics may be quite harmful to the real economy
Equivalent to a six-dimensional nonlinear map, possesses one economically meaningful steady state at which the house price corresponds to the discounted value of future rent payments. We show that this steady state may become unstable due to a Neimark–Sacker bifurcation if homebuyers extrapolate past house price changes strongly
Since Case and Shiller (2003), Case et al (2012) and Shiller (2015) report that extrapolative expectations are major drivers of such dynamics, we present a novel housing market model in which homebuyers rely on extrapolative and regressive expectation rules to forecast future house prices

Summary

Introduction

Galbraith (1994), Kindleberger and Aliber (2011) and Glaeser (2013) demonstrate that boom–bust housing market dynamics may be quite harmful to the real economy. The house price is determined via an intertemporal no-arbitrage condition and equals the discounted value of the period’s expected house price and rent payments To form their expectations, homebuyers use a mix of extrapolative and regressive expectation rules. Equivalent to a six-dimensional nonlinear map, possesses one economically meaningful steady state at which the house price corresponds to the discounted value of future rent payments. We show that this steady state may become unstable due to a Neimark–Sacker bifurcation if homebuyers extrapolate past house price changes strongly. Appendix A, B and C provides a detailed formal analysis of our model as well as a number of additional robustness checks

Literature review

The model

Analytical results

Numerical results

Conclusions