A Dynamic Model of Housing Demand: Estimation and Policy Implications

In the U.S., macroeconomic policy makers are concerned about how consumers will respond to falling incomes, nominal home prices, falling income, rising mortgage interest rates and tightening credit standards. In order to address these questions, we estimate and simulate a dynamic structural model of housing demand. In the model, consumers maximize expected discounted lifetime utility from housing services and a composite consumption good. The model allows for realistic features of the housing market including non-convex adjustment costs from buying and selling a home and credit constraints from minimum downpayment requirements. We use the forward simulation procedure of Bajari, Benkard and Levin (2007) to estimate the structural parameters, especially the elasticity of substitution between consumption and housing services, using data from the Panel Study of Income Dynamics. Given the estimated model parameters, we simulate the partial equilibrium consumption and housing and financial asset accumulation response by consumers to a labor income and home price collapse. We also assess how this response depends on the tightness of financing constraints, the size of transaction costs in housing markets and the elasticity of substitution between housing services and consumption. The simulation results demonstrate that many households do not alter their housing choice in response to these shocks, but rather adjust nondurable consumption expenditures. The intuition behind this result is simplehouseholds in the model only move two to three times before retirement (as do most households in the data). Because they are locked in, changes in housing market conditions do not influence their consumption, and