Regressive Welfare Effects of Housing Bubbles

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 have regressive welfare effects.

Entrepreneurship, Growth and Productivity With Bubbles

“…As a result, the investment multiplier of each entrepreneur decreases, which reduces aggregate investment and growth. From the expression of the investment multiplier, it is immediate to see that the leverage e¤ect of the bubble on growth weakens when the degree of pledgeability, measured by ; is smaller and disappears when = 0: 20 We conclude that it is more likely that the bubble increases growth when the degree of pledgeability is small and the start-up cost rate is large.…”

“…5 There are many other examples of models with bubbles and heterogeneous individuals. For instance, Bengui and Phan (2018) and Graczyk and Phan (2018) consider that individuals have di¤erent endowments, which separates individuals between borrowers and lenders. This distinction is also in Basco (2016) and in Kocherlakota (2009) in a model of in…nitely lived agents.…”

Bubbly Recessions

“…First, we help formalize the popular notion among policymakers that the collapse of risky bubbles can trigger inefficient recessions. A large number of papers emphasize the positive aspect of bubbles in reducing dynamic inefficiencies (e.g., Samuelson 1958;Diamond 1965;Tirole 1985) or reducing intratemporal inefficiencies in the allocation of resources (e.g., Farhi and Tirole 2011;Miao andWang 2012, 2018;Martin and Ventura 2012;Graczyk and Phan 2016;Ikeda and Phan 2018). Other papers emphasize potential ex-ante inefficiencies of speculative bubble investment in diverting resources away from productive investment (e.g., Saint-Paul 1992;Grossman and Yanagawa 1993;King and Ferguson 1993;Hirano et al 2015), generating excessive allocations of resources in certain sectors (e.g., Cahuc and Challe 2012;Miao et al 2014), generating excessive volatility (Caballero and Krishnamurthy 2006;Ikeda and Phan 2016), or generating excessive default (Kocherlakota 2009;Barlevy 2014;Bengui and Phan 2018).…”