Glaeser: In Housing, Even Hindsight Isn’t 20-20

"In Housing, Even Hindsight Isn’t 20-20" by Edward L. Glaeser.

One major point of economics is that predicting asset prices is extremely hard, and that goes for housing as well as stocks. Moreover, the last seven years should make everyone wary about predicting housing price changes.

At this point, not only is our foresight limited but our hindsight isn’t exactly 20-20 either. The housing price volatility of the last six years has been so extreme that it confounds conventional economic explanations. Over a four-year period — from February 2002 to February 2006 — the Case-Shiller index increased 68 percent in nominal terms or about 50 percent in constant dollars.

Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom, and we built hundreds of thousands of additional homes. Our current low levels of construction will continue until we work through all of this extra housing stock.

A number of pundits place the blame for the bubble on the shoulders of the former Federal Reserve chairman, Alan Greenspan. They argue that loose monetary policy caused housing prices to rise.

While lower interest rates are correlated with higher prices, the relationship is far too weak to explain the price explosion that America experienced. A 100-basis point (1 percentage point) reduction in the inflation-adjusted rate of interest is typically associated with a price increase of less than 5 percent. To get a 50 percent real increase in housing prices, real interest rates would have had to decline by more than 1,000 basis points (10 percentage points), which is not what happened.

Read Glaeser's complete article here.