By Nobuhiro Kiyotaki, Alexander Michaelides and Kalin Nikolov
This paper is a quantitatively-oriented theoretical study of the interaction between housing prices, aggregate production, and household behavior over a lifetime. We develop a life-cycle model of a production economy in which land and capital are used to build residential and commercial real estates. We find that, in an economy where the share of land in the value of real estates is large, housing prices react more to an exogenous change in expected productivity or the world interest rate, causing a large redistribution between net buyers and net sellers of houses. Changing financing constraints, however, has limited effects on housing prices.
There as been much talk about how the relaxation of borrowing constraints on US markets has driven up house prices. This paper shows that at least theoretically this need not be so, and the interest rates and productivity growth are much more important. Theory, of course, can only cover fundamentals, and bubbles may add to house prices, and those bubbles may be linked to these financing conditions. In the long run, though, bubbles are largely irrelevant, and this model indicates we should stop worrying about mortgage down-payments.