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Source link: http://archive.mises.org/10364/does-a-strong-economy-support-higher-home-prices/

Does a Strong Economy Support Higher Home Prices?

July 28, 2009 by

Lilburne’s recent article quotes Bernanke, on housing prices:

Well, unquestionably, housing prices are up quite a bit; I think it’s important to note that fundamentals are also very strong. We’ve got a growing economy, jobs, incomes. We’ve got very low mortgage rates. We’ve got demographics supporting housing growth. We’ve got restricted supply in some places. So it’s certainly understandable that prices would go up some. I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened is supported by the strength of the economy.

I dispute that low interest rates are a “fundamental” because Dr. Bernanke has so much to do with setting them; but that is a side point. Do the other conditions in his list really support higher housing prices?

Certainly supply restriction in some places would cause prices to be higher than otherwise. I’ll grant him that much.

But what about population growth, economic growth and higher incomes? Is it so obvious that these factors make housing prices higher that Bernanke doesn’t need to give any further explanation? Does this make any sense?

Economic growth means the production of more goods. As more capital is accumulated labor productivity increases, and more consumer goods can be produced per unit of labor. The purchasing power of labor tends to increase over time with respect to many goods. Why would the increased production of goods not include housing? Simple supply and demand theory tells us that the price of a goods falls when more are produced. Is housing exempt from this?

What if Bernanke had said “Yes, food prices are up quite a bit but that is explained by a growing economy, more jobs, and higher incomes”. Is that logical? Is economic growth consistent with a family being able to afford less and less food each year? Suppose he had said, “Yes the prices of all goods are up quite a bit (and families can afford less of everything than last year) but that is supported by the strength of our growing economy”. Clearly that would be a form of doublespeak.

I can construct a set of assumptions under which Bernanke’s statement might be true. Suppose that in a region where land is scarce and there are building codes that restrict building higher buildings or tear-downs of existing buildings. Then, if people’s incomes rose, it is possible that the prices of existing homes would increase because people would be bidding their higher incomes against a more or less fixed supply. Perhaps these conditions apply in some very tiny countries such as Bermuda, Luxembourg, and Hong Kong.

However, a fly-over of the United States indicates there there is plenty of unused land. Some places have restrictive zoning laws, but others don’t. And during the period when housing prices were in their ascending bubble, new home construction was above trend. If it were sufficiently profitable, even dense urban areas such as Manhattan could become more dense by replacing short buildings with tall buildings.

Another possibility is that as productivity increases, people are choosing to consume more housing – some combination of larger and/or better quality homes.

My point is not that it is impossible for rising incomes and rising home prices to co-exist, only that it requires a very special set of conditions and that, in general, we should expect the opposite. Bernanke’s blithe statement of the obvious at best requires further explanation and is at worst illogical. It is more likely, as Reisman says, that the cause is an expansion of credit.


KY Leong July 28, 2009 at 9:40 pm

It’s amazing that the central banker of the world’s most powerful nation can get away with such BS. But then aren’t we used to such nonsense from these morons already?

Geithner: printing ton’s of new money and getting the US govt into a mountain of debt IS consistent with a “strong dollar” policy?

Bernanke: paying higher interests on banks’ reserves with the Fed constitutes a clever “exit strategy”?

Clinton (mayhaps on the advice of Krugman): let’s go get Iran if the humongous Obama stimulus doesn’t work; WW III will surely get the US economy back on track and create prosperity for all.

clark July 28, 2009 at 10:14 pm

“…Simple supply and demand theory tells us that the price of a goods falls when more are produced. Is housing exempt from this?…”

I don’t know, but bullets sure seem to be. Not shot gun shells mind you, just bullets.

Lilburne July 29, 2009 at 12:38 am

Good points, Robert. Unfortunately the association of prosperity (rising real incomes) with rising house prices is so widespread, it is considered a truism. Keeping with this, today’s NPR coverage of the higher-than-expected Case-Shiller Index numbers treats them to be a self-evidently good sign for the economy.

Bob Roddis July 29, 2009 at 7:22 am

While people generally understand that inflation is occurring, they steadfastly refuse, for whatever reason, to understand that it is caused by the monetary dilution of the Fed. Since they believe that prices will always go higher and higher (because that’s just the way things are), they seek inflation hedges and real estate appeared to be the safest inflation hedge around.

I think that Austrian explanations regading the motivation for malinvestment often fail to take into account the seeking of inflation hedges by a population that believes price inflation to be inevitable but which simultaneously refuses to understand why it happens.

KP July 29, 2009 at 8:23 am


I agree with your assumptions however your statement “only that it requires a very special set of conditions and that, in general, we should expect the opposite” I feel is in correct.

I do agree with your statement about supply and demand however, housing tied to credit is almost guaranteed and no longer a special condition. It is no longer the case as it was in the past that an individual would buy his house with cash only, and most likely will buy with a loan or a mortgage.

This credit expansion as you stated in your last sentence should be emphasized in your article. With the latest housing bubble that we seen, sharp rise in labor and production, and decrease in the overall interest rate; created this disaster we see infected almost every sector of our economy.

This is not to disagree with your point, however I do believe that disassociation of the two industries is incorrect. Housing as it is currently, will rely on credit and credit expansion until there is a massive change and the reduce allotment of mortgages to the general public.

C July 29, 2009 at 10:19 am
billwald July 29, 2009 at 1:03 pm

Generally, in the US, cities with high housing costs have many good union jobs and/or a civilized climate that attracts retired people with money.

Long time ago someone asked me why I though that new colleges were being built in Florida and not in the northern plain states. Should be obvious. How many 18 year olds from southern California or Florida would want to spent the next 4 years in North Dakota even if tuition was free? No insult intended to people who have adapted to North Dakota. I’m happy for you.

mikey July 29, 2009 at 1:50 pm

“…Simple supply and demand theory tells us that the price of a goods falls when more are produced. Is housing exempt from this?…”

Not all housing is created equal.It is one thing to make the physical structure cheaper and cheaper. The land it sits on is another thing altogether.The value of the land is in the minds of people, and people can decide that certain areas have a value that is higher than the rest of us would care to pay.The supply of this highly valued land cannot be increased in through technology and production.
A market economy, growing more and more prosperous, would make more and more wealth available to bid up prices of this real estate, the ownership of which confers status.
High demand, small supply. And the supply cannot be increased.

Egosumabbas July 29, 2009 at 2:47 pm

One could also simply look at housing data over the past 100 years or so. Long term, increase in housing prices merely track inflation. On the other hand, the square footage of the average house has been increasing over the years. You get more house for you money, ergo, houses have become cheaper over time.

Of course, without fannie mae et al, houses would probably be even cheaper since it would require more cash up front and less credit, which runs opposite to the mission of GSEs.

The caveat of course is location, and prices change depending on supply and demand. The price in Gold Coast in Chicago is extraordinarily high, while home prices in Detroit are less than nothing–you literally can’t give them away.

Walt D. July 29, 2009 at 4:08 pm

What actually does it mean, to say that house prices have risen, when the price is measured in fiat currency, and the FED has been boosting the money supply out of thin air? It would seem that we need to quote prices in terms of something that can not be inflated at will, such as gold, or something that does have some intrinsic value, such as oil or a basket of commodities. (It is more difficult for the FED to pump oil than it is to “pump money”.)
Also, what does Bernanke mean by “an improving economy” ? Higher stock market prices, boosted by artificially low interest rates, and Enronized reporting of the condition of financial institutions?
Incidentally, since you made the right call the last time round, do you consider the latest increase in stock prices as the beginning of another bubble?
I think we can see that Bernanke’s strategy is to do what is necessary to inflate real estate prices so that the currently under-collateralized real estate assets held by banks become fully secured.

Gerry Flaychy July 29, 2009 at 6:22 pm

” Simple supply and demand theory tells us that the price of a goods falls when more are produced. Is housing exempt from this? ” _Robert Blumen

This theory also tells us that it is so when at the same time all other things are held constant.

Was it the case for housing in 2005 ?

Robert Blumen July 29, 2009 at 10:39 pm

Bob Roddis:

Good point about inflation hedges. People who have borrowed at a fixed rate to buy an inflating good (notice I don’t say asset) have done pretty well.


If your point is that the increasing quantity of credit in excess of actual savings is mainly responsible for the rising home prices, then I agree


re: Cities attract retired people with money, it seems to me that this can’t in itself be responsible for a the trend in home prices to be correlated with economic activity. If people with money move from A to B, driving up home prices in A, then why isn’t there a supply response in A to bring home prices back down? And shouldn’t home prices fall in B as the people who move sell their homes?


Concerning land scarcity being the driver, I agree that land scarcity could be an explanation for a correlation between a strong economy and rising home prices. It’s not exactly true that the supply can’t be increased. Technological progress makes it possible to build on what were less habitable areas; for example, air conditioning has made very hot areas much more populated. And while land surface per se is fixed, technology has made it possible to build taller structures which house more people. But more fundamentally, do we have land scarcity in the US? There is plenty of unbuilt land. Sure, land in some areas is very expensive but that’s not the same thing as saying that we are running out of places to build on.

Walt D.

I doubt that we are in a new bubble. I don’t think that we are done deflating the last two bubbles.

Gerry Flaychy:

No in 2005, the supply of homes was increasing and the prices were going up. So either the theory of supply and demand is wrong or there were other variables influencing home prices. I suspect that latter with the other variable being the increase in the supply of credit to home buyers.

olmedo July 31, 2009 at 8:59 am

Keynes totally screwed the concept of economic growth. from a one of increase in efficiencies making life easier for everyone to a concept of increase in consumption not accounted by the CPI statistics.

that is why Bernake is fighting to bring reflation back.

and it is also why many people specially in the third world are not that happy with “economic growth”. the more growth statistics increase the more their real income falls.

for me it all a pyramid scheme.

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