The best two sentences I read this morning

by on July 26, 2008 at 7:19 am in Economics | Permalink

In this paper, we present a simple model of housing bubbles that
predicts that places with more elastic housing supply have fewer and
shorter bubbles, with smaller price increases. However, the welfare
consequences of bubbles may actually be higher in more elastic places
because those places will overbuild more in response to a bubble.

That’s from Ed Glaeser, Joseph Gyourko, and Albert Saiz.  Here is the paper, ungated here, here is Mark Thoma’s commentary.

1 John Thacker July 26, 2008 at 9:26 am

It’s an interesting paper that largely agrees with some thoughts that I’ve had. One thing I’d distinguish in a more complicated model is between short-term and long-term elasticity of housing supply. Some states and locales have time-consuming or complicated regulation for housing permits but eventually do grant most starts. In those places, the short-term supply is fairly inelastic, because it takes some time for the regulations to be satisfied, but the long-term supply fairly elastic.

I’d argue that in some cases such places get the worst of both worlds. Bubbles last longer and have larger price increases because it takes a long time for supply to respond to demand. However, they will still manage to overbuild a great deal in response to a bubble, perhaps even more than in more elastic places.

In summary, I postulate that in such locales:
1) Prices begin to rise in a bubble.
2) In response, additional supply is planned to meet (bubble-related) demand.
3) However, the regulation process takes a long time, and in the meantime prices continue to rise.
4) Even more supply is planned and regulatory process started in response to additional price increases.
5) Enough additional supply is finally finished together with other factors to end the bubble, and prices start to decrease.
6) However, additional housing starts that have already gone through most of the regulatory process are still finished.
7) This drives down housing costs in response even further than in a locale with quicker regulation.

I’d argue that this model explains some places like, e.g., Northern Virginia. The amount of overbuilding certainly seems greater here than in North Carolina or Texas, where smaller price increases occurred.

2 Mercutio.Mont July 26, 2008 at 12:37 pm

“…places with more elastic housing supply have fewer and shorter bubbles, with smaller price increases.”

Phoenix, Las Vegas, and the exurbs of Metro LA have led the nation in both price increases and, now, price falls. All three areas have been exceptionally elastic – housing stock increased dramatically. These may in fact be the most elastic major metro areas in the USA. And yet they have been – so far at least – the worst affected by the housing bubble.

3 Michael F. Martin July 26, 2008 at 4:51 pm

From the paper: “Ideally, we would model the decision of existing owners to sell as an optimization problem, but this would greatly complicate the model.”

Why not model the decision to sell as a Poisson distribution in frequency rather than modeling in an exogenous shock? Then the problem becomes a linear optimization in frequency of supply and demand.

4 Jeff Hallman July 27, 2008 at 9:18 am

The measure of supply-side conditions they use is a measure of the amount of buildable land that depends solely upon geography. Notably, it does not include any information about regulatory barriers to construction. They do report that they also experimented with a measure of the strictness of the local regulatory environment. They report (in a footnote) that they obtained “qualitatively similar” results from those regressions. Since zoning may be endogenous while geography is fixed, they prefer using the latter.

Still, I’d like to see them report the results of omitted-variable tests to see if the zoning variable has any explanatory power beyond that already contributed by the geography-based measure. The correlation between the two is only 0.4, so multicolinearity is not likely to be a problem. It is, after all, easy to think of supply responses that may be ruled out by zoning but not by geography, such as replacing neighborhoods of older, widely-spaced houses with rows of townhouses and condos.

5 Jeff Hallman July 27, 2008 at 9:34 am

Geez, now why did that post twice?

Tyler shoud also have read a bit further into the paper. The quote

“the welfare consequences of bubbles may actually be higher in more elastic places”

applies to a model in which buyers’ expect prices to go up forever. When that assumption is changed to buyers expect rising prices only until a period when prices don’t go up, at which time they revert to construction costs, the duration of bubbles is reduced. The net welfare effect of elasticity is then ambiguous, as greater elasticity induces a more rapid supply response to a shorter bubble.

Comments on this entry are closed.

Previous post:

Next post: