Housing, consumption, and the economy: Why do house prices become misaligned, and what are the consequences? Andrew Farlow University of Oxford Department of Economics, and Oriel College Guest Lecture (with expanded post-lecture notes) The London Business School 2 June 2005
University of Oxford
Department of Economics, and Oriel College
(with expanded post-lecture notes)
The London Business School
2 June 2005
This lecture is based on papers to be found at:
Source: Halifax UK Real House Price Growth (annualized)
Shiller, R.J., ‘Irrational Exuberance’ 2000 page xi
Source: Bank of England Inflation Report, May 2004, p7, Chart 1.10.
“A peculiar psychological disorder known as ‘physics envy'...We would love to have three laws that explain 99% of economic behaviour; instead, we have about 99 laws that explain maybe 3% of economic behaviour. Nevertheless, we like to talk as if we are dealing with physical phenomena.”
Andrew Lo, MIT, financial economist
* Stochastic process xt is considered a fair game if Et[xt+1]=0. In the case here, Et[xt+1]=Et[rt+1]-rt.
* Several recent interesting models of bubbles have all agents rational, but that this not common knowledge, with the rest of the framework essentially classical. See Abreu, D. and Brunnermeier, M. K. 2003.
* Sharpe, W.F., G.L. Alexander and J.V. Bailey, 1995
“The bottom line...is that theory by itself does not inevitably lead a researcher to a presumption of market efficiency. At the very least, theory leaves a researcher with an open mine on the crucial issues....market efficiency only emerges as an extreme special case, unlikely to hold under plausible assumptions.”
Schleifer, A., 2000, p16.
* Or, since the alternative to owning is renting, the opportunity cost of owning (via payment of interest) is compared to the alternative of renting. So if the typical rent is falling as house prices are rising, then buying housing and renting it to yourself is getting more expensive than letting someone else buy it and you rent it from them. There are, however, some weighty problems in dealing with the tax advantage of housing and the different tax treatments of renting.
(The nomenclature here is identical to that of Abraham and Hendershott)
* Based on 30 US Metropolitan cities for the period 1977-1992 (Abraham, and Hendershott, ibid).
Stephen Ross (a learned financial economist).
Sharpe, W., and G. Alexander, “Investments.” 4th Edition, quoted in Shleifer, A., and R. W. Vishny, 1997.
Federal Reserve Chairman Alan Greenspan, 17 April 2002, Testimony before the Joint Economic Committee.
“Without such a nonlinearity or dummies for the spikes in the data, the equation standard error more than doubles”. They find that by taking the frenzy component and downside risk term out, the shift in the income growth component and the 1980s real interest rate effect become “quite insignificant”. In conclusion they comment:“These results suggest that the omission of a non-linear ‘frenzy’ effect is a major specification error. The omission worsens the fit and fails to support the predictions of economic theory regarding the consequences of financial liberalisation, which are supported by a better specified model including a ‘frenzy’ effect.”
Muellbauer, J., and A. Murphy, 1997
*Case, K.E., and R. J. Shiller, 1988 (also found in Shiller, R.J., 1989, p403-430).
Net UK average residential yields (GSISG figures)
Net U.K. Average Residential Rental Yield less real 20 Year Government Bond Yield (GSISG calculation)
Volatility in real house pricesHMT p41
Source: Bank of England Inflation Report May 2004, p12, Chart 2.1.
Source: Bank of England Quarterly Bulletin, Spring 2004, J Power, Chart 1.
Source: Bank of England Quarterly Bulletin Spring 2004, J Power, Chart 11.
Source: Bank of England Inflation Report November 2004
Source: BOE Inflation Report May 2004, p12, Chart 2.3, based on the Family Expenditure Survey.
Source: Bank of England Inflation Report May 2004, p 13, Chart 2.4.
Source: Bank of England Inflation Report November 2004, p12 Chart B.
Source: Bank of England, Office for National Statistics and HM Treasury calculations. Chart 5.5, HMT 2004 p52, not updated.
Source: HMT Table 5.4, p51. Source: Bank of England and Office for National Statistics.
Source: HMT 2004, Chart 6.3. p. 60. Source: Office for National Statistics and Office of the Deputy Prime Minister.
Source: HM Treasury, 2004, p64.
Source: IMF 2004, data from: Haver Analytics; IMF, International Financial Statistics; national sources;
OECD; and IMF staff calculations.
Source: IMF 2004, data from: Haver Analytics; IMF, International Financial Statistics; national sources; OECD;
and IMF staff calculations.
Source: Extracted from IMF 2004
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