
I realize that people get tired of me continually harping on the “never reason from a . . . ” maxim, but it’s a continual problem.
A recent NBER study of housing by Schuyler Louie, John A. Mondragon, and Johannes Wieland had the following abstract:
The standard view of housing markets holds that the flexibility of local housing supply–shaped by factors like geography and regulation–strongly affects the response of house prices, house quantities and population to rising housing demand. However, from 2000 to 2020, we find that higher income growth predicts the same growth in house prices, housing quantity, and population regardless of a city’s estimated housing supply elasticity. We find the same pattern when we expand the sample to 1980 to 2020, use different elasticity measures, and when we instrument for local housing demand. Using a general demand-and-supply framework, we show that our fidings imply that constrained housing supply is relatively unimportant in explaining differences in rising house prices among U.S. cities. These results challenge the prevailing view of local housing and labor markets and suggest that easing housing supply constraints may not yield the anticipated improvements in housing affordability.
When I first read that abstract, I was skeptical. How is it possible that building constraints are not the primary cause of high prices in places like California and the Northeast? It turns out that my skepticism was justified. A new paper by Michael Weibe has the following abstract:
Louie et al. (2025) (henceforth LMW) claim to provide evidence that housing supply constraints are quantitatively unimportant in understanding changes in housing prices and quantities in the United States. In this short comment, I show that LMW’s empirical model is unidentified. LMW models housing demand as a function of population and average income. However, supply constraints are a key determinant of population growth: newcomers are less able to move into a city that restricts the construction of new housing. Hence, LMW does not have exogenous variation in demand. Accordingly, the empirical results are uninformative about the role the housing supply constraints.
If you are having trouble understanding the problem in the first paper, consider the following analogy. Suppose someone said, “High gas taxes are not the real reason why Europeans consume less gasoline (per capita) than America, the actual reason is that they have smaller cars and use public transport.” The problem with that claim is pretty obvious, right? The tendency of Europeans to use smaller cars and public transport partly reflects the fact that gas taxes are extremely high in Europe. Economists call this the “identification problem.” It is important to identify whether market changes are caused by demand shifts or supply shifts. Neither price nor quantity can answer this question.
Not very many people have moved to California in recent years, but that’s not because there’s little demand to live here. Rather, it’s because supply constraints have pushed housing prices in California to levels far higher than in most other states.
READER COMMENTS
Student
May 13 2025 at 2:46pm
Well, empirically, the problem is even worse than Michael Wiebe points out.
Even if the endogeneity problem were fixed, LMW proceed as if metro areas are isolated islands, idepedent of each other. In reality people arbitrage across nearby locations while builders operate region‑wide (spillovers in P and Q). Furthermore, state policies, coastal amenity booms, and regional credit cycles hit neighbors together (spatially correlated shocks).
So even if psi and Y didnt covary, explicitly modeling the spillovers (spatial correlation) means loosening any one market affects a whole region, so LMW’s “local only” counterfactual understates gains.
In other words…
1.) spatial error correlation (or a missing SAR/SDM lag) pushes the price‑on‑income slope toward zero, exactly pattern LMW celebrate as constraints dont matter.
2.) once neighboring city growth feeds back into local income, Y_i^b is correlated with the composite error, violating the exclusion restriction.
Correcting for spatial (in particular spatial Durbin) effects typically increases the estimated role of supply constraints, because constrained metros (coastal California as an example) are clustered and reinforce each other’s shortages.
Scott Sumner
May 14 2025 at 12:13pm
Thanks, good comment.
Craig
May 14 2025 at 9:17am
If somebody moves out of state and they own a home, they will sell it to somebody else. If they vacate an apartnent, the landlord will likely rent it to somebody else. Significant demographic factor is there are fewer children oer household. So for population to stay the same in general the number of houaing units needs to increase. Rural county I reside in TN has this issue, declining population on the backdrop of more homes.
Scott Sumner
May 14 2025 at 12:15pm
Yes, when you read that places like Chicago are 25% down from their population peak, it’s almost all due to smaller households, not fewer households. A few extreme cases in the rustbelt do have fewer households, such as Detroit.
David Seltzer
May 14 2025 at 11:13am
Scott: It is important to identify whether market changes are caused by demand shifts or supply shifts. Neither price nor quantity can answer this question. Per Thomas Sowell; “The first lesson of economics is scarcity.” If building and zoning constraints move housing supply curve up and to the left, ceteris paribus, housing prices would be higher relative to locals where there are fewer similar constraints on housing supply. Geo-arbitrage is a reflection of the difference.
Scott Sumner
May 14 2025 at 12:16pm
Yes, that’s clearly what’s going on in California and the Northeast.
Henri Hein
May 14 2025 at 1:15pm
I’m guilty of reasoning from a population change.
(The Former) East Germany is close to Denmark. I grew up watching stories about East Germans escaping. I saw pictures of the barbed wire fences and armed guards. I read and heard about people killed or wounded during escape attempts. In the meantime, I heard from family members and teachers how great Socialism is. (Most of my family are various shades of socialist). To me, even as a kid, I didn’t have to know much about what was going on in East Germany to understand that if people risk getting shot at to escape from there, it couldn’t have been good.
David Seltzer
May 14 2025 at 1:28pm
Henri: Good point. The wall wasn’t built to keep people from trying to get into that “utopia.”
I don’t recall anyone braving razor wire to settle in the GDR. Anything but a democratic republic.
Comments are closed.