Wednesday, April 26, 2017

Learning from The Great Recession....NOT

I have been teaching Michael Woodford's "Financial Intermediation and Macroeconomic Analysis" (JEP) in my money and banking class.  It does what I want - adds financial intermediation to an AE/MP or AD/PC model. You have two interest rates, what fi's charge borrowers and what they pay lenders. Policy targets the latter.  The supply of intermediation depends on intermediary capital and on the wedge between the borrowing and saving rates - this latter by means of a value-at-risk constraint. A decrease in bank capital increases the wedge and reduces AE at every lending rate. So far so good. But in passing, Woodford, citing William Buiter, declares that the collapse of housing wealth had no effect on [spending, since housing isn't net wealth.  An owner of a house who resides therein sees the value of her house fall, but experiences an offsetting reduction in the cost of housing services,

Well, that's fine, if you're willing to assume the house prices always equal their fundamental values - the discounted value of future rents.  As long, that is, as you assume that housing prices before the crash contained no bubble component!

Are you kidding me?

2 comments: said...

I think the problem is the claim that there is an offset in the cost of housing services. For those who own their own home, there is no change, unless interest rates fall and they have adjustable rate mortgages. For renters, no change unless rents are going down with prices, the point of your comment about fundamentals as I read it, Kevin. But neither is likely to happen during the crash of a housing bubble, so, yeah, a bunch of nonsense basically.

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