Do We Want High House Prices or Affordable Housing? Lessons on the Government Debt

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Wednesday, 07 August 2013 13:17

Matt Yglesias asked this question of President Obama on his twitter feed. It's a very good question and reporters at President Obama's speech in Phoenix would have been asking it if they were awake.

In case folks missed it, President Obama touted immigration reform as one of the actions he would do for housing. He said that this would raise house prices.

There probably is some truth to this. Normalizing the status of 10-12 million immigrants living in the country will allow more of them to be homeowners, which should have some upward impact on house prices.

(Don't get too carried away on this one. The incremental boost to homeownership will be modest. Furthermore, these people were living somewhere. If they had been living in rental units, these units would become vacant. Then rents would fall, other things equal. That would cause some would be homeowners to rent instead and for some rental units to be converted to ownership units. In other words, don't expect to make your fortune on immigration reform sending the price of your home soaring.)

However this raises a basic question, why would we think that high house prices are good? Obviously high house prices are good for people who own homes. But they are bad news for people who are renting and hope to become homeowners or young people just starting their own households.

Saying that we want high house prices is in effect saying that we want to transfer wealth from those who don't own homes to those who do. That looks a lot like upward redistribution, which is not ordinarily an explicit goal of government policy, even if that is often an outcome.

The upward redistribution attributable to rising home prices can look a bit like the debt burden story that people in Washington whine about. The line is that our public debt of $12.2 trillion (76.3 percent of GDP) is a burden that we pass on to future generations.

There can be some sense in which this is true when the economy is near full employment. In that situation the argument is that deficit spending raises interest rates and therefore discourages investment. With less investment the economy will be less productive and therefore poorer. Insofar as this is the story with large deficits, we can say that deficits hurt future generations, since they will cause the economy to be smaller and less productive.

There is also the story people push to take advantage of racist and xenophobic sentiments, that the government is financing its debt by borrowing from foreigners, most importantly China. The problem with this story, aside from the fact that the vast majority of the debt is still held domestically, is that our indebtedness to foreigners is determined by the trade deficit, not the budget deficit.

The ability of China and other foreign countries to buy up U.S. government bonds depends on their having a trade surplus with the United States. Their trade surplus is in turn the result of over-valued dollar that makes our goods less competitive in world markets. A large budget deficit can contribute to an over-valued dollar by leading to higher interest rates and therefore making it more attractive for foreigners to buy dollar denominated assets. 

But this effect is indirect and still requires the dollar to rise. If people don't want China to own U.S. assets then they should be yelling about the over-valued dollar, not the budget deficit. (By adding to growth, a budget deficit will lead to more imports and therefore a larger trade deficit, but that is true of increased investment and consumption as well. Anything that boosts growth will worsen the trade deficit, other things equal.)

However, when the economy is seriously depressed, as is the case today, it is not plausible to tell a story of budget deficits raising interest rates and crowding out investment. With interest rates still at extraordinarily low levels, deficits are more likely to boost investment by increasing demand than to crowd it out through any interest rate effect.

In this situation, the deficit does not make future generations as a whole worse off. If anything, by boosting investment (both public and private) and putting children's parents back to work, it is likely to make future generations as a whole better off.

There is still the question of who owns the debt. While ownership of the debt will be passed on largely to future generations, to some extent it will lead to higher consumption by current generations. In this sense, it is very similar to the story of higher house prices.

Suppose that the government increases the debt by $4 trillion over the next 4 four years. This means that households will have $4 trillion in assets (i.e. government bonds) they would not have otherwise. (We're ignoring the evil foreigners and also the pension funds and other institutional investors.) Much of this wealth will simply be passed on to future generations as either money spent on them in their upbringing or as an inheritance.

But some of this wealth will be translated into additional consumption. This is money that holders of the bonds will spend on themselves, effectively pulling away money from our children and grandchildren. But this is an almost identical story to housing wealth. If the value of residential real estate rises by 20 percent, it would mean that today's homeowners have roughly $4 trillion more in wealth than would otherwise be the case.

As with the story of government debt, most of this money would be spent on or inherited by future generations. However some of this additional wealth would translate into more consumption by the current generation of homeowners on themselves.

The question that awake reporters should have asked the president is how can he think it is good that we transfer wealth from future generations to current generations from higher home prices, but he somehow is greatly troubled (along with the other Very Serious People) by the rise in the government debt? This is the same story.

Come on Fox News, you've got President Obama contradicting himself in the hot Arizona sun. Why don't you tear him to shreds?