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REGRESSIVE WELFARE EFFECTS OF HOUSING BUBBLES

Published online by Cambridge University Press:  26 December 2019

Andrew Graczyk  and
Toan Phan
Andrew Graczyk
Affiliation:
Wake Forest University
Toan Phan*
Affiliation:
The Federal Reserve Bank of Richmond and VCREME
*
Address correspondence to: Toan Phan, The Federal Reserve Bank of Richmond, 701 E Byrd St, Richmond, VA23219, USA. e-mail: toanvphan@gmail.com.
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Abstract

We analyze the welfare effects of asset bubbles in a model with income inequality and financial friction. We show that a bubble that emerges in the value of housing, a durable asset that is fundamentally useful for everyone, has regressive welfare effects. By raising the housing price, the bubble benefits high-income savers but negatively affects low-income borrowers. The key intuition is that, by creating a bubble in the market price, savers’ demand for the housing asset for investment purposes imposes a negative externality on borrowers, who only demand the housing asset for utility purposes. The model also implies a feedback loop: high-income inequality depresses the interest rates, facilitating the existence of housing bubbles, which in turn has regressive welfare effects.

Keywords

Rational BubbleInequalityHousingFinancial Friction
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 8 , December 2021 , pp. 2102 - 2127
Copyright
© Cambridge University Press 2019

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Footnotes

We thank the editor, the associate editor, two anonymous referees, Julien Bengui, Ippei Fujiwara, Lutz Hendricks, Guido Menzio, and Andrii Parkhomenko for helpful suggestions. Toan Phan is funded by Vietnam National Foundation for Science and Technology Development under grant number 502.01-2017.12. The views expressed herein are those of the authors and not those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

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