Are Housing Prices too Low?

We propose a sufficient statistic to evaluate whether housing prices are inefficiently low for maximizing steady-state household welfare when housing has collateral value. The statistic is based on the insight that at the optimal housing price, the consumption gains induced by higher housing prices offset the welfare costs of a reduction in housing uses and household leisure. To apply the methodology, we use Italian data over the 1993-2006 period. As a source of exogenous variation for housing prices we rely on a share-shift instrument exploiting the facts that (i) owing to seminal historical and cultural episodes, foreign nationals have preferences for buying houses in different Italian provinces and (ii) shifts in a country’s foreign investment are largely exogenous to the economic performance of specific Italian provinces. The data indicate that higher housing prices increase local consumption more than they decrease leisure and housing use by locals, suggesting that housing prices were inefficiently low.