Income Gaps, Credit Constraints, and House Price Fluctuations
CHEN Jinzhi, WEN Xingchun, SONG Lu
School of Government Audit, Nanjing Audit University; School of Banking and Finance, University of International Business and Economics; National Academy of Development and Strategy, Renmin University of China
Summary:
Income gaps, credit constraints, and housing prices are long-established and prominent topics of social concern. International Monetary Fund (IMF) figures from September 2020 report a record high global real house price index of 167.26 (using the first quarter of 2000 as the base period). The data show a rising trend in 47 of the 63 sampled countries and regions. Furthermore, since the U.S. subprime mortgage crisis, many scholars have investigated the potential relationships between income gaps and credit constraints. Numerous papers show that relaxation of credit constraints contributes significantly to rising house prices. Although this finding raises a natural question of how income gaps influence house prices through credit channels, this question is rarely mentioned in the literature. Theoretically, because different income groups have different housing demands, changes in income distribution should significantly affect house prices through the amplification effect of credit leverage. Therefore, this paper aims to establish a general framework to interpret house price changes through the channel of income gaps affecting credit constraints. It shows that income gaps, credit constraints, and house prices are closely related. Specifically, an income gap reduction improves the relative income levels of low-income groups, which relaxes their credit constraints for house purchases. The relaxation of credit constraints makes the (aggregate) housing liquidity premium decrease. However, low-income groups have higher housing marginal utility, and access to external financing increases the housing market weight of low-income groups that have rising incomes. Thus, relaxation of credit constraints raises the housing marginal utility for society as a whole, which offsets the negative impact that liquidity premium decreases have on house prices, and ultimately increases house prices overall. This paper's findings are further supported by empirical analysis of cross-country panel data, which shows that the rising share of income going to low-income groups has significantly stronger effects on credit constraints and house prices than does growth in the incomes of high-income groups. This paper makes three main contributions. First, existing explanations of the effects of income gaps on housing prices are mainly based on static analyses; because our model introduces the effects of credit constraints, this paper incorporates dynamic characteristics. Second, previous studies often use representative agent models to investigate the relationships between credit constraints and house prices. This paper enriches the research dimension by including analysis of heterogeneous agents. Third, the literature mainly studies the relationships between income gaps and house prices directly from the empirical level but does not conduct in-depth analysis of the transmission mechanism. In contrast, the construction of this paper's heterogeneous agent model enables a clear description of the transmission mechanisms between income gaps, credit constraints, and house prices. Importantly for policy makers, our results provide new insights into the factors that cause house prices to rise. Finally, this paper has real-world importance. At present, China's real estate market trends are different in first-and second-tier cities than they are in third-and fourth-tier cities. CREIS data show approximately 10% growth in the land supply and transaction volumes of China's first-and second-tier cities in 2020. In contrast, the data show the land supply and transaction volumes of China's third-and fourth-tier cities decreasing by half in the same year. China's real estate market is deeply tied with bank credit, government revenue, and social investment. If the market encounters a sudden and severe decline, it will inevitably lead to serious systemic financial risks. As far as the current situation is concerned, the proposal of “six priorities and stability in six areas” shows the Chinese central government's concern about the population's livelihood, employment, financial stability, and investment expectations. Narrowing the income gap is itself an important means to protect the basic population's livelihood. This paper shows the further importance of narrowing the income gap to expand the scale of society's use of financing, prevent house prices from collapsing, and stabilize investment expectations. With particular relevance to the “Gray Rhino” real estate market, which is characterized by slowing economic growth and exhaustion of land resources, mechanisms should be considered to prevent the systemic financial risks caused by a “hard landing” of the real estate market. Management of the real economic function of the real estate industry is particularly important at present because the industry has the characteristics of large-scale, long industrial chains, growing employment, and increasing fiscal contributions. Relative to some short-term policies, more analysis should be applied to the basic aspects of income distribution and its influence on the domestic market and the domestic economic cycle.
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