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A study forthcoming in the Federal Reserve Bank of New York’s Economic Policy Review concludes that the rapid rise in housing prices in the past decade is not symptomatic of a housing bubble that will burst, and that there is not a risk of weakness to the aggregate U.S. economy resulting from a potential decline in regional housing prices.
In Are Home Prices the Next ‘Bubble’? economists Jonathan McCarthy and Richard W. Peach maintain that the strength of market fundamentals is responsible for the run-up in housing prices nationally. Although home prices have risen strongly, increases in family income and low nominal mortgage rates have meant that homes have remained affordable on a cash flow basis. Furthermore, their analysis shows that rents and prices are not out of line in an environment where nominal interest rates remain historically low. In discussing a possible bubble, the authors subscribe to a standard economic definition as stated by Nobelist Joseph Stiglitz: a bubble exists if prices are high today because investors believe future selling prices will be higher, even though fundamental factors do not justify the prices.
On the national level, the authors note that aggregate real home prices declined only moderately, even in periods of weak economic growth combined with high nominal interest rates. Regionally, McCarthy and Peach conclude that in states along the east and west coasts, where home price appreciation has been strongest recently, there is some potential for the price of housing to soften. They observe that prices in these areas are subject to a possible decline because housing is relatively inelastic and home prices historically have been volatile. However, they note that regional price declines in the past have not had significant negative effects on the broader economy.
Jonathan McCarthy is a senior economist and Richard W. Peach a vice president at the Federal Reserve Bank of New York.