Welfare Effects of Housing Price Appreciation in an Economy with Binding Credit Constraints

Abstract

This paper analyzes the eects of recent housing price appreciation on aggregate welfare. It generalizes previously available results by considering credit constraints together with endogeneity of housing prices. First, housing price appreciation implies improvement in aggregate welfare in a model with exogenous housing price and credit constraints. Then, housing price is endogenized by modeling the supply side of the housing market. In this model, housing price appreciation is caused by supply and demand shocks. The supply shock originates from a change in building permit cost. The demand shifts are generated by changes in household income and interest rates. Both credit-constrained and unconstrained versions of this model are considered. Finally, the combination of observed demand and supply shocks is used to quantify aggregate welfare eects on the US housing market from 1995 to 2004. The results demonstrate that demand shocks dominated during that period and the aggrerate welfare improved as a result of housing price appreciation.