on the close relationship between usercosts, which are the costs of owning ahouse for a year, and rents.We’ll start with some observationsabout the housing market, thenreview recent economic research thatanalyzes house-price dynamics. Sinceeconomists are still trying to improvetheir understanding of how houseprices move, there are many theoriesthat explain house-price dynamicsother than the one presented in thisarticle. We will take a brief look atsome of the other theories. Then we’lldiscuss the theory that we focus on inthis article and examine how elementsthat affect house prices, according toour theory, change over time and theimplications of such changes for houseprices. Finally, we’ll carry out a simplenumerical exercise to see what fractionof the recent rise in house pricescan be accounted for by the theorypresented here and by the data.Interested readers are encouragedto look at Wenli Li and Fang Yang'srelated
article, whichanalyzes the economic benefits andcosts of homeownership.
SOME OBSERVATIONS ABOUT HOUSE PRICES
The trend of the average houseprice between 1975 and 2009 is shownin Figure 1. This is a
index in thesense that the house prices shown inthe figure are relative to the pricesof nonhousing goods and services. Aconstant
house price doesn't meanthat the
house price (the oneswe see in newspaper ads) is constant;rather, it most likely means that houseprices are, on average, rising at thesame pace as other goods we regularlypurchase. The average house pricerose about 1.5 percent faster thanother prices per year over this period.What is striking about the figure isthat the trend is relatively flat until themid-1990s. Since then, there has beena substantial increase (until the endof 2006) and a substantial drop (since2007). Around the end of 2006, whenthe average house price peaked, houseprices were about 60 percent higherthan their level in the mid-1990s.The recent increase and declinein the average house price have beenaccompanied by similar changes in thehomeownership rate (Figure 2). Thefigure plots both the homeownershiprate (left scale) and the averagereal house-price index (right scale),which was shown in Figure 1. Untilthe mid-1990s, about 64 percent of U.S. households lived in housingthat they owned. But in 2005, thehomeownership rate went up to 69percent and then came down to 67percent. Matthew Chambers, CarlosGarriga, and Don Schlagenhauf find that the increase is an outcomeof demographic changes as well asdevelopments in the mortgage loanmarket, in particular, the proliferationof new types of mortgage loans withlow down-payment requirements andlow introductory rates.Although this article focuses onhow and why the national averagehouse price moves, it is important tokeep in mind that behind the averagehouse-price dynamics, there aresubstantial differences across regionsof the U.S. (Figure 3). The Pacific,New England, and Middle Atlanticregions exhibit the most volatilemovements. On the other hand, theaverage house price in the West-SouthCentral region changed very littlebetween 1975 and 2009. The house-price bubble and subsequent burst thatwe often hear about does not applyequally to all regions of the U.S. Ingeneral, the regions that experienced alarger increase in house prices are alsoexperiencing a larger drop in houseprices. The level of average houseprices in regions with volatile house-price movements is still high comparedwith that in the mid-1990s.House-price dispersion across U.S.
2 2011 21
Real House Price Index for the U.S. (1975 = 100)FIGURE 1
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 20052008
Data source: Federal Housing Finance Agency