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The Fed says Home Prices Driven by Income, not Availability

The Federal Reserve posted an article last year that shows that housing costs are driven by income and not by housing availability.

https://fredblog.stlouisfed.org/2017/10/incomes-determine-house-prices/?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=fredblog

YIMBY proponents  argue that if we build more housing, the price of housing will drop.  This comes from the economic idea of supply and demand.  If the supply of bananas increases, then the price that people are willing to pay should drop.  Likewise, if there are fewer bananas, then the price should increase.

But housing is not like bananas.  Everyone just has one home.  People don’t rush out to buy a second house when prices drop or go without a home when prices increase.  In economic terms, this means demand for housing is “inelastic.”  “Inelastic” means that when the price goes up, consumers’ buying habits stay about the same, and when the price goes down, consumers’ buying habits also remain unchanged. How inelastic is housing?  The Federal Reserve found in another study that for every 5% increase in the supply of housing, costs would drop .5%.  Hardly anything.  Here is  a link to the study.

https://www.federalreserve.gov/econres/feds/files/2018035pap.pdf

So what does account for housing prices? What the Federal Reserve found was a very strong correlation to income.  When incomes go up and people can afford to pay more for housing, developers charge more for housing.  When incomes go down, developers charge less for housing.

The study shows that even in Seattle, New York and San Francisco where housing is very expensive, changes in housing costs are highly correlated with changes in incomes.  As incomes went up in these cities, housing costs followed.  This makes sense as developers charge whatever the market will bear.  When the market will bear more, they charge more.

 

 

 

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