8. Housing Price Shocks
Nominal housing wealth in the model is PKH*KH, where KH is the real stock of housing and PKH is the market price of KH. Nominal housing wealth enters in the definition of AA (equation 89), which is the wealth variable that affects consumption demand (equations 1, 2, and 3). PKH is determined (equation 55) as PSI14*PD, where PD is the price deflator for domestic sales and PSI14 is exogenous. It is thus possible to change housing wealth in the model by changing PSI14. For example, if you think housing prices are going to fall (relative to PD) in the future, you can decrease PSI14. This is done in the experiment in this chapter. It allows you to see the estimated effects on the economy of falling housing prices.

Experiment 8.1: Decrease in PSI14

  • Decrease PSI14 by 20 percent for the forecast period. Solve the model.
  1. How much did nominal housing wealth, PKH*KH, fall? How much did the real wealth variable AA fall?
  2. What effect did this change have on the consumption variables, CS, CN, and CD? On the labor supply variables, L1, L2, L3, and LM? (Note that there is a lag of one quarter in the effects of AA on household behavior.)
  3. How did the Fed respond to the fall in housing prices?
  4. What is roughly the loss of real GNP per year as a result of the fall in housing prices?