Identifying House Price Booms, Bubbles and Busts: A Disequilibrium Analysis from Chaos Theory

Abstract

This research was motivated by the excesses of public policy since 2008 in an attempt to re-inflate the housing markets. Is it even possible or desirable to utilize such a vast amount of public resources to inflate a single sector such as housing that suffered from such a spectacular bubble and collapse? The consequences suggest that, as a way to bolster real household incomes and aggregate output, these policies have disappointed. In contrast, there is a fear that the monetary stimuli will lead to unsustainable housing price inflation, if not a bubble. I address these questions in the analysis from the standpoint of determining the stable equilibrium and sustainable house price appreciation rates consistent with the growth of median household income. The problem of identifying stable house price appreciation is to first identify the major proximate determinants of household demand for housing. A second is to show empirically the movement, deviation, and variation of these factors over time compared to housing prices. I use median household income as the major demand factor for houses and median single family house prices as an indicator of the price. A third is determining the stable equilibrium of the growth of these factors and the appreciation of housing prices consistent with them. And a fourth is the adjustment process when there are small deviations from steady-state equilibrium compared to when deviations are large. It is this last distinction where the chaos theory of self-organizing systems and irreversibility of the housing market system enters to explain how the adjustment process is chaotic in this case. I conclude that, as of the beginning of June 2016, the evidence is overwhelming that housing price appreciation is in a bubble that will likely lead to significant declines in house price appreciation if not in house prices. An important policy recommendation to mitigate these declines and hasten a house price recovery follows. The continuation of expansionary monetary policies will only delay house price adjustments and lead to more severe price declines.