Working Paper

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.

Keywords: rational bubbles; inequality; housing; financial frictions;

JEL Classification: E10; E21; E44;

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2018-04-18

Number: 18-10

Pages: 32 pages