House prices, endogenous productivity, and the effects of government spending shocks

We present aggregate and regional evidence showing that U.S. house prices increase persistently in response to positive shocks to fiscal spending. In sharp contrast to this, house prices decline in conventional dynamic general equilibrium models, where shocks that have short-lived effects on the shadow value of housing inevitably generate negative comovement between households’ marginal utility of consumption and house prices (see Barsky et al., 2007). In response to an increase in government spending, the negative wealth effect exerted by the simultaneous increase in the present-value tax burden increases the marginal utility of consumption. Even overcoming the consumption crowding-out puzzle is not sufficient to resolve this shortcoming. To tackle this problem, we extend an otherwise standard model embedding a lender-borrower relationship with alternative – yet, potentially complementary – propagation channels that leverage the expansion in total factor productivity stemming from a positive shock to fiscal spending, so as to contrast the negative wealth effect of higher taxes. This class of models succeeds in generating a persistent expansion in house prices, although the propagation required to match the data is stronger – in some cases significantly so – than what is typically found in the literature. The positive interplay between house prices and productivity finds support in both aggregate and regional data.