Are Home Prices the Next “Bubble”?

The rapid increase in home prices over the past several years has raised concerns about the existence of a speculative bubble in this asset market. A closely related concern—irrespective of any existing bubble—is whether home prices are susceptible to a steep decline that could have a severe impact on the broader economy. Indeed, home prices have been rising rapidly. Since 1995, real home prices have increased about 36 percent, roughly double the increase of previous home price booms in the late 1970s and late 1980s (Chart 1).1 Moreover, home prices continued to rise strongly during the 2001 recession, the sluggish recovery through mid-2003, and the recent period of more rapid growth. Many analysts argue that the recent growth in home prices is symptomatic of a housing bubble that will burst—just as the stock market bubble did—thus erasing a significant portion of household wealth.2 They add that such a decline in household wealth would have adverse macroeconomic effects, as already overextended consumers reduce spending to boost saving and improve their weakened financial condition. In this article, we assess the evidence in support of a bubble in U.S. home prices and discuss whether a severe decline in these prices is likely. We also examine the effects of a steep drop in home prices on the broader national economy.