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Federal Reserve Bank of Richmond
Working Paper
Regressive Welfare Effects of Housing Bubbles
Andrew Graczyk
Toan Phan
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.


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Andrew Graczyk & Toan Phan, Regressive Welfare Effects of Housing Bubbles, Federal Reserve Bank of Richmond, Working Paper 18-10, 18 Apr 2018.
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Keywords: rational bubble; inequality; housing; financial friction
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