Scott Alexander recently argued that building more housing in a given city causes housing prices to go up in that city. He acknowledged that previous studies had found the opposite relationship, but suggested that he was more impressed by the strong positive correlation between population and prices when there are big changes:
Matt Yglesias tries to debunk the claim that building more houses raises local house prices. He presents several studies showing that, at least on the marginal street-by-street level, this isn’t true.
I’m nervous disagreeing with him, and his studies seem good. But I find looking for tiny effects on the margin less convincing than looking for gigantic effects at the tails. When you do that, he has to be wrong, right?
I also believe that looking at the tails (big changes) is often more revealing than looking at lots of small changes. But only if you’ve got causality right. And in this case, Alexander hasn’t necessarily done so.
Here’s an analogy: Suppose you wanted to compare the mainstream view of monetary policy (raising interest rates is deflationary) with the NeoFisherian view (raising interest rates is inflationary.) So you focused your attention on cases where there were truly massive increases in interest rates—say to 20%, 30% or 50%. In virtually all of those cases, inflation will be very high when nominal interest rates are very high. That seems to support the NeoFisherian position. (I wonder how Alexander feels about this debate.)
But this sort of correlation doesn’t address the issue of causation, and thus most economists reject the notion that a high interest rate policy is inflationary, despite the clear correlation. They see this as an example of “reasoning from a price change.”
In my research on market reactions to policy news during the 1930s, I argued that big changes were especially revealing. But in those sorts of “event studies” the direction of causation is clear—policy news leads to immediate changes in asset prices.
Big changes don’t help if the house price model you are criticizing is also consistent with the stylized fact that bigger cities tend to be more expensive. That stylized fact would be true even if building more houses reduced house prices at the margin.
READER COMMENTS
David S
May 12 2023 at 2:28pm
Kevin Erdmann has done a good job of revealing the big changes in housing costs for people along the income spectrum in supply constrained cities. If there’s a housing shortage caused by regulation it impacts low income earners to a greater degree than high income earners, creating an “off balance” distribution line. If you only look at median home prices in a high demand/low supply city you can miss this distinguishing feature–and erroneously conclude that no amount of housing production can lower that median price.
Central banks have it easier than homebuilders. The money supply can be changed overnight, whereas housing takes a long time to build. Although, there have been times where the Fed waited far too long to make a move and suffering was prolonged longer than it needed to be. 2008 through 2010 comes to mind.
Philippe Bélanger
May 12 2023 at 5:41pm
If I understand correctly, Alexander is criticizing a model where supply restrictions on housing can explain the variation in prices. I don’t see how this is consistent with the fact that price and density are positively correlated. There is no reason to assume that cities all have the same restrictions on housing. So, if the model he is criticizing is true, we would expect to see some large cities with very low prices. And we don’t see that.
I think it’s true that the density-causes-prices model is consistent with the idea that a small increase in housing stock lowers prices. This would be especially true if the increase in density doesn’t bring many new employers into the city. But the correlation between price and density suggests that if the city keeps increasing supply, eventually new employers will come in and the demand for houses will increase, overwhelming the effect of supply.
Kevin erdmann
May 12 2023 at 7:38pm
The reason there is a positive correlation between density and price is because political supply constraints scale with the number of neighbors that are in a position to object to new housing.
Kevin erdmann
May 12 2023 at 7:41pm
The agglomeration folks think that the trick is that the demand curve slopes upward, but the actual problem is that the long run supply curve slopes down. You can see this quite explicitly whenever the planning department in the very expensive cities receives objections to new units because “these are too expensive. We need affordable units, not luxury market rate units.”
Philippe Bélanger
May 12 2023 at 11:27pm
Why would denser cities be better at preventing the development of new housing? It could easily go the other way: with a denser neighborhood, you have more people to convince, so it’s harder to organize. I may be wrong, but my sense is that some of the most NIMBY cities in the US are places like Palo Alto and Cupertino in California, which are not especially dense.
Kevin Erdmann
May 13 2023 at 12:46am
Well, yes. The new, unobstructed building has to be in the exurbs, mostly. LA and San Francisco metro areas show up at the top of his density charts because their suburbs tend to be somewhat more dense than east coast suburbs, so the density involved in the correlation is quite low, even if he then imagines that its about Manhattan. I mean, Las Vegas is the 5th most dense metro area in his first chart.
Scott Sumner
May 13 2023 at 12:43am
“So, if the model he is criticizing is true, we would expect to see some large cities with very low prices. And we don’t see that.”
It depends what you mean by very low. Houston’s a large city with relatively low prices and weak zoning restrictions. Big cities will never have extremely low prices for reasons I explained in my previous post.
The point is that more housing reduces prices at the margin, even though bigger cities tend to be more expensive for other reasons.
Spencer
May 13 2023 at 7:22am
Housing is impacted by oligarchic constraints. A doctor I knew owned over 400 houses.
Dale Doback
May 13 2023 at 10:00am
Scott (Alexander) is falling prey to Simpson’s Paradox. The correlation he sees between price and population reverses when you analyze within groups and account for confounding variables like regulation. Ironically, I think Scott (Sumner) makes this same mistake when analyzing real income rises since the 1980’s.
Scott Sumner
May 14 2023 at 1:27am
Care to explain?
Dale Doback
May 14 2023 at 2:17am
Every once in awhile you do a post critical of the notion that real incomes have stagnated over the last 40 or so years. You cite the aggregate data that shows real income gains, but if you look at demographic groups (clustered data) you would see that incomes have in fact stagnated. As you point out, plotting population vs housing prices or inflation vs interest rates can be misleading unless you cluster to avoid confounding variables a la Simpson’s Paradox.
Scott Sumner
May 14 2023 at 12:30pm
That’s false. The gains would probably be even larger in that case, as many Americans are immigrants who have seen huge income gains from their previous country. Lots of Hispanics do blue color jobs that whites used to do. The children of these workers often went to college and now have higher paying jobs.
In any case, I recall life in the 1980s. The idea that average material living standards have not improved is so silly I have a hard time understanding how anyone older than 60 could take it seriously.
Also, the fallacy you discuss is different from the problem with Scott Alexander’s argument.
Dale Doback
May 14 2023 at 3:26pm
The stock of housing is positively correlated with housing prices in a geographic area, which SA finds very convincing. The trend reverses when looking at clusters of similar cities or down to a street to street level, but SA rejects that analysis even though it stronger evidence than the former trend. Similarly, one can look at the total living standards over time or compare the living standards of individual jobs, geographies, etc.
BC
May 13 2023 at 2:36pm
(1) Holding the demand curve fixed, an outward shift of the supply curve, e.g., building more housing, causes housing prices to drop. Full stop.
(2) Holding the supply curve fixed, an outward shift of the demand curve, e.g., an improvement in the desirability of a neighborhood, causes housing prices to rise.
It may be possible that an increase in housing can improve the desirability of a neighborhood through agglomeration effects, attracting more businesses and amenities, and other factors. It’s also possible that the associated outward shift of the demand curve can increase housing prices by more than the outward shift of the supply curve decreased housing prices. But, that doesn’t change the truth of (1) and claims like, “Building more housing can cause housing prices to go up,” without explicitly acknowledging the truth of (1) are misleading. It’s especially misleading to just present empirical data that appears to support the claim without describing the mechanism (2), as if the building of housing itself is what caused the increase in housing prices. Especially misleading because it appears to contradict (1). On top of that, other factors could have improved desirability first, which in turn attracted some house building (but not enough to reduce housing prices net of the improved desirability), so that it may even be inaccurate to attribute the increased demand (2) to the house building without additional direct evidence.
To give an example that progressives might understand, suppose investing in social services actually worked, resulting in fewer people experiencing homelessness, fewer people experiencing the committing of crimes, more people doing well in school, etc. That made a neighborhood more desirable causing housing prices to go up. It would be misleading to just say, “Investing in social services, when effective, actually increases housing prices, which risks pricing long-term residents out of their homes,” without mentioning the mechanisms of fewer homeless, less crime, and better schools.
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