Thursday, April 1, 2004

Housing Inflation Does Not Hurt Consumers

STANFORD GRADUATE SCHOOL OF BUSINESS—If you sold a house anywhere in the country within the past 20 years, chances are you made something of a killing. Housing prices have risen steadily for decades, up 7 percent a year since 1995—and as much as 12 percent a year in the San Francisco Bay Area. This has been great news for homeowners, but terrible news for home buyers. Rising prices have meant more and more first-time homebuyers are being locked out of the market.

Stories of consumers struggling to scrape together down payments and meet expensive mortgages are legion, but are people worse off now, as a result of the rise in housing prices? No, say researchers Lanier Benkard, Patrick Bajari, and John Krainer in a recent study. In fact, they conclude, the net effect of house price inflation on consumers has been virtually nil.

Benkard, associate professor of economics at the Stanford Graduate School of Business; Bajari, associate professor of economics at Duke University; and Krainer, an economist with the Federal Reserve Bank in San Francisco, have found that losses that buyers incur are exactly offset in the larger economy by the gains accrued by sellers. "A person buying a house will pay a high price, and the person selling will acquire that money," says Benkard. "The aggregate effect of all those transactions means that, overall, there is no net loss to consumers. Assets are simply redistributed among them."

The situation is different, he explains, when prices rise on consumable goods, such as oil. "Once oil is used, it's gone, and there's no way of recuperating what you paid for it," says Benkard. "So when prices rise on nondurable goods, consumers, in general, are hurt. The money goes to someone else outside the consumer pool."

Unlike house price inflation, the rising price for construction and renovation has actually cost consumers $127 per year, the researchers found. Consumers who buy newly constructed houses or pay maintenance costs on homes they own "lose" a small amount to builders and contractors, but it could be worse. "In the grand scheme of things, $127 a year isn't very much," says Benkard.

The study provides a fresh look at how house price inflation affects the economy. In discussing house price inflation, Benkard says: "The press says that it's bad for the economy because it [price inflation] prevents people from being able to afford to buy. The Fed, however, says it's good for the economy because theoretically it gives people more assets to work with, and therefore should stimulate spending. Ours is the only paper that tries to look at both these effects together."

The rising housing market has been a mainstay of the U.S. economy during the slump of the past few years, with housing costs making up about a third of the consumer price index. About 70 percent of the population owns homes, says Benkard.

Interestingly, one place in the country where the findings of the study don't quite hold is the San Francisco Bay Area. "The market there has a higher percentage of young people and renters than does the rest of the country," Benkard says. "These populations are always worse off when housing prices rise because they are less able to afford to buy. So in this localized economy, where house price inflation has been particularly high, consumers have experienced more net loss than people across the country as a whole."

Those lucky citizens who own the foundation under their feet, says Benkard, "are essentially being paid to live in a home, once their total costs and selling price over time are taken into consideration." For nonowners, the discovery that house price inflation does not have much of an effect on consumers as a whole may be cold comfort. Benkard sympathizes but says: "It's not the job of the economist to determine whether these movements are good or bad, but rather to observe and describe what's going on."

Related Information

House Prices and Consumer Welfare
Patrick Bajari, C. Lanier Benkard, and John Krainer
Stanford Research Paper No. 1840, January 2004

Taking the Guesswork Out of Pricing Commercial Leases
Research by Steve Grenadier

A. Dougherty and R. Van Order, "Inflation, Housing Costs, and the Consumer Price Index," American Economic Review, 1982, 154-164

J. Poterba, "Tax Subsidies to Owner-Occupied Housing: An Asset Market Approach," Quarterly Journal of Economics, 1984, 729-752