Sunday, January 15, 2012

Interest Rates as the Cause of the House Price Bubble? Not So Much

Ken Kuttner survey the old evidence, adds some new evidence, and concludes that home prices are fairly inelastic with respect to interest rates. Because the effect is weak:

… Making the case that low interest rates cause bubbles would require showing that house prices
tend to overreact to rate reductions. Although the previous decade’s house price boom was out of
proportion to the interest rate decline, there is no evidence that this happens systematically. The
puzzle is why house prices are less sensitive to interest rates than theory says they should be, not
more so.

This suggests that while low interest rates may have been part of the problem with the run-up in house prices from 1995-2007, they were not the major part. This is the position of people (on the left and right) who say the housing bubble was all the fault of Greenspan’s monetary policy when he was in charge of the Fed.

Like most things in macro, my guess is that 10 years from now we’re going to be pointing out that the housing and financial crisis was the result of a lot of little things, not one big thing.

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