US house prices have to fluctuate more than elsewhere

In retrospect, the recent swing in house prices in the US a unusually large by international comparison. And it is not just the last swing, if you look at local markets, there have been many episodes before the current one where house prices went through a wild ride up or down. What is so special about the US? Is it irrational exuberance, like Robert Shiller has claimed? Or does this have to do with some characteristics of the US economy?

Nobuhiro Kiyotaki, Alexander Michaelides and Kalin Nikolov design a life-cycle DSGE model of the house market with land and mortgages. There is also capital that is used to build residences on land, as well as commercial real estate. The interest rate is exogenous, which allows to observe what happens when the world interest rate changes. It turns out that real estate prices then fluctuate more if land is a larger share in it value. The same happens with fluctuations in productivity. Why is that so?

The reason is a change in fundamentals leads to large reallocations towards real estate. If land is plentiful, so you want to use it, but this requires large amounts of capital to build all those houses, and in the meanwhile house prices go up. Things are much smoother when land is less important for real estate, like it is in Europe. And interestingly, the downpayment to obtain a mortgage has no impact on this volatility of prices, countering some recent claims.