Thursday, July 22, 2010

Half Thought Through Post

Matt Yglesias posted this graph:

He then writes:
The reason the details of housing policy don’t matter, it seems to me, is that our policy errors tended to affect the level of real estate prices whereas the relevant factors in prompting the recession had to do with unsustainable trends. Both sets of problems should be fixed, and it’s good that the recession has increased attention to the misallocation of resources involved in large covert subsidies for owner-occupied housing, but they’re pretty much separate issues as far as I can tell.

So, I'm looking at this graph above and thinking to myself, okay that's prices. But your standard supply and demand has two axes. Price is on the vertical and quantity is the horizontal.

Let's say subsidies or government policy shifts the demand curve. The static analysis says that both prices and supply increase. I've taken the liberty of creating some rudimentary graphs.

Initial Supply and Demand:

After a policy shift that increases demand:
As you can see the intersection of the two lines is at greater price and quantity.

However, the thing that Matt's graph got me thinking about is the slope of the supply curve.  Let's say the supply market was highly competitive and they can increase supply without increasing their costs too much.  Then, the supply curve would be closer to horizontal.  Consequently, the graph might look like this:
In this case, rightward shift in the demand curve wouldn't result in as big a rise in prices as the shift indicated above.  Instead, the quantity supplied would increase.  If we assume that each of the above countries in Matt's graph have differing supply slopes, then the graph is really only telling half the story. 

What does this all mean?

Well, it's possible that the long-standing subsidies of home ownership in the United States created an environment where established firms could refine their processes and become very efficient and competitive. This, combined with the natural benefits of space that the United States has, may have manifested the bubble in an unsustainable increase in both prices and quantity.

Other countries, with less ability to ramp up home production, saw steep increases in prices where some of that manifested as more quantity here.  Consequently, we have an economy that not only has an oversupply of housing, which will eventually clear given some combination of time and price reductions, but also a structural problem whereby we have too much home production capability relative to a reasonable demand moving forward over the medium term while the market rebalances.

All that said, the apparent correlation between multiple countries' prices would indicate at least some international, systematic factors contributed. 

FLG feels like he's missing some crucial point here in his analysis.


The Ancient said...

MY writes: large covert subsidies for owner-occupied housing

1) He's still renting, isn't he?

2) Does he think for a moment there aren't large covert subsidies for commercial real estate? Or rental housing?

FLG said...

Re 1) I think I remember him writing about buying a place a few years back, but I don't know.

Re 2) I cannot overstate how much I question his economic analysis.

Creative Commons License
This work is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.