Events at CERGE-EI

Alessandro Galesi

CEMFI (Centro de Estudios Monetarios y Financieros), Madrid, Spain

Author: Alessandro Galesi

Abstract: I consider an open economy with collateralized debt and two sectors, construction and non-construction, whose productivities grow at different rates.  I show that when productivity in construction falls, house prices increase. The effect is amplified when the rate at which the economy can borrow is low. As house prices increase, the collateral constraint gets relaxed. If the borrowing rate is sufficiently low, households find optimal to accumulate foreign debt and these capital inflows lead to surges in both residential investment and land prices. In this way house prices rise even further.  I calibrate the economy to match the US evidence, which is characterized by a pronounced slowdown in construction productivity and a low borrowing rate. While the productivity slowdown in construction alone can account for the long-run trend in house prices over the 1970’s - 2000’s, its combination with the low interest rate is crucial to generate the increases in prices of land and housing of the early 2000’s.  This interaction also accounts for key stylized facts of the US housing cycle: (i) the positive correlation between housing prices and residential investment; (ii) land prices are twice as volatile as house prices;  (iii) part of the worsening of the current account. In a closed economy the productivity slowdown in construction cannot account for these facts, hence I conclude that its interaction with the low interest rate is what helps to explain US house prices. Using a Panel VAR with sign restrictions I also show that this mechanism can be important to explain the dynamics of house prices across OECD countries.

JEL Codes: D24, L74, O18, O41

Keywords: US house prices, construction, productivity slowdown, Baumol cost disease.

Full Text: “Can the Productivity Slowdown in Construction Explain US House Prices?”