Housing Bubbles and Policy Analysis

This paper provides a theory of credit-driven housing bubbles in an infinite-horizon production economy. Entrepreneurs face idiosyncratic investment tax distortions and credit constraints. Housing is an illiquid asset and also serves as collateral for borrowing. A housing bubble can form because houses command a liquidity premium. The housing bubble can provide liquidity and relax credit constraints, but can also generate inefficient overinvestment. Its net effect is to reduce welfare. Property taxes, Tobin's taxes, macroprudential policy, and credit policy can prevent the formation of a housing bubble.