An Econometric Analysis of the Role of Financial Intermediaries in Postwar Residential Building Cycles*

Abstract

THE PURPOSE OF THIS STUDY is to develop a model of the residential construction sector of the U.S. economy with particular emphasis on the financial factors which provide a link between construction activity and the monetary sector. It was undertaken as part of a larger project to incorporate monetary policy variables into the econometric model constructed by the Research Seminar in Quantitative Economics at The University of Michigan. As this is an annual model designed for short-run forecasting and policy analysis, we have estimated our equations for the residential construction sector using postwar annual data. Our model consists of a set of equations which determine the flow of funds through financial intermediaries and their influence on construction activity. The rate of accumulation of savings deposits is assumed to depend on interest rates and personal financial saving. The inflow of deposits together with interest rates and other variables then determine the volume of commitments made by financial institutions to supply residential mortgage funds. The supply of mortgage commitments then affects housing starts and residential construction expenditures. Housing starts are also assumed to depend on the level of inventories of houses under construction and vacant units, the ratio of an index of rents to an index of construction costs, net household formations and personal disposable income.The results indicate that interest rates have a substantial influence on construction activity, but that the resulting changes in the Gross National Product are small relative to the cyclical fluctuations experienced in the postwar period. This influence operates not only through the effect of changes in long-term rates on the mortgage lending of financial intermediaries, but also through the sensitivity to short-term rates of the flows of deposits into these institutions. In addition, it was found that the substantial increase in the rate of accumulation of savings deposits by households during the recent period 1961-63 played a key role in maintaining the high volume of housing starts that took place. This increase occurred as a result of the rapid increase in household holdings of financial assets in general, rather than as a result of shifting out of marketable securities in response to a decline in interest rates, as was the case in earlier periods of increasing building activity such as 1954 and 1958.

Integrating the Real and Financial via the Linkage of Financial Flow

“…Despite recognition of the importance of credit availability, financial flows make only a rare appearance in contemporary macro-models.13 Some recent examples are the introduction of bond finance as an explanatory variable in business fixed investment equations,14 mortgage borrowing in housing expenditure equations, and financial sources of funds in financial-intermediary loan functions. 15 In another study based on the Japanese economy, availability of central bank finance is made the strategic factor determining spending in a "funds-shortage" situation."' Paradoxically, Lindbeck's availability model,17 since elaborated by Shapiro,"8 does not make use of the financial flow in the sense of a source of finance.…”

The Making of a Post-Keynesian Economist

“…Sparks (1967) comes close to adopting this approach. His study places heavy emphasis on the mortgage market and the flow of savings deposits at the financial intermediaries.…”

“…Many studies in the 1960s (such as Albert, 1962;Guttentag, 1961;Maisel, 1963;Sparks, 1967) attempted to provide theoretical explanations for the post-war housing cycles in the United States. John's explanation departed from these studies, however, by taking account of 'the portfolio adjustments undertaken by the household sector in response to changes in different yield differentials' (Cornwall, 1972, p. 185) and emphasising the supply of funds and the process of disintermediation as a primary cause of housing cycles (Cornwall, 1972, pp.…”

Disequilibrium in Housing Models

“…Sparks' model [18] is an attempt "to combine Maisel's approach with a more detailed treatment of the supply of mortgage funds" (p. 304).…”