Regressive Welfare Effects of Housing Bubbles

Abstract

We analyze the welfare effects of asset bubbles in a model with income inequality and financial friction. We show that a bubble that emerges in the value of housing, a durable asset that is fundamentally useful for everyone, has regressive welfare effects. By raising the housing price, the bubble benefits high-income savers but negatively affects low-income borrowers. The key intuition is that, by creating a bubble in the market price, savers’ demand for the housing asset for investment purposes imposes a negative externality on borrowers, who only demand the housing asset for utility purposes. The model also implies a feedback loop: high-income inequality depresses the interest rates, facilitating the existence of housing bubbles, which in turn has regressive welfare effects.

Rational housing demand bubble

“…A part of the literature considers that houses are pure speculative assets without fundamental value (see, Miao et al (2014), Chen and Wen (2017), Martin et al (2021) and Clain-Chamosset-Yvrard and Seegmuller (2019)). The second line in the literature considers that houses also provide housing services or rents (see, Arce and Lopez-Salido (2011), Basco (2014), Hillebrand and Kikuchi (2015), Zhou (2015) and Graczyk and Phan (2019)). Our contribution is in this second line of the literature.…”