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Macroeconomic Effects of Over-investment in Housing in an Aggregative Model of Economic Activity

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  • Hian Teck Hoon

    (School of Economics, Singapore Management University)

Abstract

Is there a theoretical basis for the view that the end of a period of over-investment necessarily leads to a period of below-normal employment as the excess capital stock is run down? We study the repercussions of a false boom in housing driven by prior expectations of future housing prices not justified by fundamentals. When these expectations are corrected, the result is a precipitous drop in housing prices and, on that account alone, some drop in employment. There is also a bulge in the housing stock. In the closed economy case, the downward shift of the term structure of interest rates due to the excess housing stock props up housing prices above the normal steady-state level, so the drop of housing prices “undershoots.” Although this transient elevation of housing prices has a positive demand-wage effect on employment, we show that the wealth effect from owning a higher housing stock and a negative Hicks-Lucas-Rapping effect of lower interest rates dominate, so employment drops initially to a below-normal level. The slump gradually subsides as the housing overhang wears off. In the case of a small open economy that faces a world of perfect capital mobility and takes as given the world interest rate, there are two possibilities. If housing services are instantaneously tradeable and perfect substitutes for foreign ones, so purchasing power parity holds, the end of the bubble causes housing prices to drop precisely to the steady-state level. Since there is no undershooting, the wealth effect of the housing overhang is unopposed and the slump is deeper. If domestic and foreign housing services are imperfect substitutes, the country will suffer a period with a weak real exchange rate, thus to a drop of housing prices that “overshoots” the normal level. Here the slump in employment is worsened by the exaggerated fall in housing prices below the steady-state level.

Suggested Citation

  • Hian Teck Hoon, 2010. "Macroeconomic Effects of Over-investment in Housing in an Aggregative Model of Economic Activity," Working Papers 22-2010, Singapore Management University, School of Economics.
  • Handle: RePEc:siu:wpaper:22-2010
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    References listed on IDEAS

    as
    1. Hian Teck Hoon, 2009. "Payroll Taxes, Wealth and Employment in Neoclassical Theory: Neutrality or Non-neutrality?," Working Papers 08-2009, Singapore Management University, School of Economics.
    2. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-1187, December.
    3. Zoega Gylfi, 2010. "The Financial Crisis: Joblessness and Investmentlessness," Capitalism and Society, De Gruyter, vol. 5(2), pages 1-28, October.
    4. Phelps Edmund S., 2010. "The Slump, the Recovery and the "New Normal"," Capitalism and Society, De Gruyter, vol. 5(2), pages 1-19, October.
    5. Calvo, Guillermo A., 1987. "Real exchange rate dynamics with nominal parities Structural change and overshooting," Journal of International Economics, Elsevier, vol. 22(1-2), pages 141-155, February.
    6. Weil, Philippe, 1989. "Overlapping families of infinitely-lived agents," Journal of Public Economics, Elsevier, vol. 38(2), pages 183-198, March.
    7. Obstfeld, Maurice, 1989. "Fiscal deficits and relative prices in a growing world economy," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 461-484, May.
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    Cited by:

    1. Phelps Edmund S., 2010. "The Slump, the Recovery and the "New Normal"," Capitalism and Society, De Gruyter, vol. 5(2), pages 1-19, October.
    2. Ekkehard Ernst & Faten Saliba, 2018. "Are House Prices Responsible for Unemployment Persistence?," Open Economies Review, Springer, vol. 29(4), pages 795-833, September.

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    More about this item

    Keywords

    Housing stock; housing prices; over-investment; employment;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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