Home Ownership, Housing Collateral and Aggregate Fluctuations
Background:
The World Economy has undergone a remarkable transformation over the past two decades. Inflation has fallen and is now very low and stable, while aggregate output and consumption volatility have declined across the developed world (except in Japan). These changes have been accompanied by large shifts in financial prices. Real estate prices have risen relative to household incomes. Despite substantial share price volatility, it appears that the equity risk premium may have fallen too.
At the same time, aggregate household debt has risen sharply, especially in the US and UK. This has led to concern amongst a number of policy institutions such as the IMF and the Bank of England that the high levels of household debt and housing prices will make economies more vulnerable to shocks, endangering the macro-economic stability that has prevailed since the early 1990s. As household debt grows across the developed world, households, which were hitherto unaffected by monetary policy may, as a result, become more vulnerable to monetary policy or other macroeconomic shocks.
Japan's economic experience since the 1980s illustrates the potential dangers. Despite a stable inflation rate, Japan experienced a spectacular increase in stock and real estate prices. This was followed by the 1990s crash and a prolonged recession causing substantial damage to the financial system. Japan's recent experience raises the question of whether such events were unique to japan or whether they may materialise in other developed economies as well.
This project involves a theoretical and empirical ivestigation of these competing conjectures. We plan to develop a structural model of the "household as a small business", in which agents derive utility from non-durables and housing. Crucially, we will assume imperfect contract enforcement, which implies that debtors will repay their debts only if these debts are secured. And because housing is the only durable asset in our model, it is the natural source of collateral. Our focus on housing collateral is in line with substantial micro level evidence in the UK and the US to suggest that dwellings are an important source of collateral for households.
Researchers:
Dr Alexander Michaelides
Prof Nobuhiro Kiyotaki
London School of Economics
Contact:
Dr A Michaleides
Department of Economics
London School of Economics
Houghton Street
London
WC2A 2AE
Tel: 020 7955 6857
email: A.Michaelides@lse.ac.uk
Duration of Research:
April 2006 - April 2009
