A Theory of Housing Demand Shocks

By Zheng Liu, Pengfei Wang and Tao Zha


Housing demand shocks are an important source of housing price fluctuations and, through the collateral channel, they drive macroeconomic fluctuations as well. However, these reduced-form shocks in the standard macro models fail to generate the observed large fluctuations in the housing price-to-rent ratio. We build a tractable heterogeneous-agent model that provides a microeconomic foundation for housing demand shocks. Households with high marginal utility of housing face binding credit constraints, giving rise to a liquidity premium in the aggregated housing Euler equation. The liquidity premium drives a wedge between the house price and the average rent and allows credit supply shocks to generate large fluctuations in house prices and the price-to-rent ratio.

In other words, house prices are very volatile because of the households who insist of having as much house as possible as allowed by the bank. They are very sensitive to economic conditions and are the marginal buyers, thus driving prices.


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