Abstract:
This paper provides an equilibrium framework to organize the following empirical observations on the
U.S. housing market from 1975 to 2007: (i) housing tenure and vacancies were approximately
constant, (ii) rents were approximately constant, and (iii) in the late 1990s there was a large house price appreciation. Borrowing ideas from search and matching theory, and closing the model with selffulfilling beliefs about the housing market, the model generates a house price bubble as a consequence of multiple underlying steady state equilibria. To select a deterministic equilibrium, household confidence is assumed to take one of two sunspot-driven values: normal or exuberant. When
confidence is normal, both rents and house prices are low. When confidence is exuberant, both rents
and house prices are high. Randomization over these two equilibria implies a substantial increase in
house prices and constant rents as the probability of the exuberant state increases, although it is not realized. The model can explain a house price bubble as a rational expectations equilibrium driven by self-fulfilling beliefs.
