Where are Housing Prices Headed from Here?

Real housing prices may come down somewhat, but not significantly below their lows this spring.

Housing Supply and Demand

My reasoning: housing construction cannot go below its lows of this spring, because that would create, and then intensify, a housing shortage. Children are still being born, immigrants are still moving to America, and (many) teenagers still aspire to get out of their parents’ house. That is, demand will continue to grow, and somebody has to build the houses to satisfy demand.

Of course, construction businesses do not care about surplus/shortage per se: they want to make money. The way that the market ensures that housing construction will continue is by having a housing price that stays at or above the cost of construction. Construction businesses respond by making more houses.

Note I do NOT claim that real housing prices will necessarily rise (more details on “The anatomy of a housing recovery“). They could rise — perhaps significantly for a while (that depends on the reasons for the housing cycle in the first place, on which I’ll write more later) — but ultimately they’ll be about where they are now. Moreover, I am confident that NEITHER real housing prices nor the pace of housing construction will return to their previous highs any time in the next five years.

Simply put, my definition of a “housing recovery” is not a huge increase in real housing prices (more details on “The anatomy of a housing recovery“). Of course, (absent a deflation) my definition of a housing recovery does mean that nominal housing prices will trend up.

Where I differ from some Gurus

If real housing prices fall significantly below their lows of this spring, or the pace of housing construction fails to pick up, then we have evidence I have missed something critical. Maybe demand turns out to be stagnant for a number of years. Maybe banks stop making loans. But I am skeptical that these forces will be powerful enough to overwhelm the basic supply and demand forces I have outlined.

In contrast, Professors Shiller and Krugman have been saying that nominal housing prices are likely to get significantly lower. Absent a deflation, it follows that they think real houses prices will fall even more than that.

Composition Bias and Possible Downward Wiggles

Someone emailed me that housing prices indices are plagued by “composition bias”: the indices move up and down because the types of houses included in them change, and not because the price of any one of those houses actually moved in the direction of the index. Specifically, he suggested that housing prices might not have increased in the last month or two.

I agree that composition bias needs to be considered, and admire Professors Case and Shiller for the hard work they’ve done on this measurement problem (and appreciate the email — I would like to thank the author by name but he asked to be anonymous). It is likely that housing price indices will show some downward wiggles merely due to composition bias.

However, if today we are at the point that composition biases, rather than a CRASH (a genuine and significant surplus of houses), are driving the price measures, then I rest my case: the crash is over, or at least so diminished that we cannot distinguish it from technical issues that may be boring, but sometimes demand attention from those of us doing quantitative work.

About Casey B. Mulligan 76 Articles

Affiliation: University of Chicago

Casey B. Mulligan is a Professor in the Department of Economics. Mulligan first joined the University of Chicago in 1991 as a graduate student, and received his Ph.D. in Economics from the University of Chicago in 1993.

He has also served as a Visiting Professor teaching public economics at Harvard University, Clemson University, and Irving B. Harris Graduate School of Public Policy Studies at the University of Chicago.

Mulligan is author of the 1997 book Parental Priorities and Economic Inequality, which studies economic models of, and statistical evidence on, the intergenerational transmission of economic status. His recent research is concerned with capital and labor taxation, with particular emphasis on tax incidence and positive theories of public policy. His recent work includes Market Responses to the Panic of 2008 (a book-in-process with Chicago graduate student Luke Threinen) and published articles such as “Selection, Investment, and Women’s Relative Wages,” “Deadweight Costs and the Size of Government,” “Do Democracies have Different Public Policies than Nondemocracies?,” “The Extent of the Market and the Supply of Regulation,” “What do Aggregate Consumption Euler Equations Say about the Capital Income Tax Burden?,” and “Public Policies as Specification Errors.” Mulligan has reported on some of these results in the Chicago Tribune, the Chicago Sun-Times, the Wall Street Journal, and the New York Times.

He is affiliated with a number of professional organizations, including the National Bureau of Economic Research, the George J. Stigler Center for the Study of the Economy and the State, and the Population Research Center. He is also the recipient of numerous awards and fellowships, including those from the National Science Foundation, the Alfred P. Sloan Foundation, the Smith- Richardson Foundation, and the John M. Olin Foundation.

Visit: Supply and Demand (in that order)

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