Housing, Leisure and Growth

Sungmin Park

Seminar in International Economic Theory-I

Professor Young-Han Kim
Sunkyunkwan University

1 May 2017

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Outline

1 Motivation

2 Main Idea

3 Model

4 Solution

5 Discussion

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 Motivation

Motivation
While housing is an important topic in recent macroeconomics
literature, modeling it in a simple and meaningful way is not easy
Literature consider houses as that which serves the dual nature of a
consumption good and an asset (e.g., Cocco [2005])
Households choose between investing in houses and capital, deriving
utility both from the housing service produced by the former and the
regular goods produced by the latter
Meanwhile, it introduces frictions such as (a) nondivisibility, (b)
nontradability of dividends, (c) illiquidity, and (d) collateralizability, in
order to differentiate houses from regular consumption goods
Piazzesi and Schneider (2016) provides a comprehensive summary
This motivates me to ask the following question: what is a house,
really?
Equivalently, what is the most fundametal characteristic of houses that
differentiates them from regular consumption good or financial assets?
More specifically, can housing be successfully modeled in a way
consistent with various observed phenomena of growth?
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 Main Idea

Main Idea
My claim is that houses are essentially leisure-complementing
assets
People derive utility from houses but only so far as they have enough
leisure; similarly, people derive utility from leisure but only so far as
they have a good enough place to live
For example, consider a friend of mine who works at an investment
bank in NYC (high pay, low leisure):
he does not care much to live in a nice house because he only gets 34
hours of leisure a day anyway (including sleep!)
For another example, consider Korea in the 1950-60s when people did
not have nice houses:
People then took the so-called 3D-jobs more willingly than do now,
because staying at their houses was not hugely attractive anyway
I show that modelling houses as above can yield rich dynamics of
growth in terms of leisure, consumption, output and house prices
I put housing directly into household utility in the canonical growth
model in a way that multiplies leisure, and show that this slight
modification can yield such results
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 Model

Model
(Preferences) Households derive periodic utility directly from the
stock of housing (ht ) by augmenting the amount of leisure (1 nt )
they enjoy:
h i1
1 h (1 n )1
ct t t
u(ct , ht , 1 nt ) = +
1 |
1 {z }
| {z }
from consumption from housing and leisure

Given the capital and housing stocks (k0 , h0 ), household maximizes

the discounted sum of the infinite sequence of periodic utility, so that

X
V (k0 , h0 ) = max t u(ct , ht , 1 nt ),
ct ,nt ,it ,xt
t=0

where it and xt denote capital and housing investment, respectively,

subject to technological and budget constraints (next slide)
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 Model

Model (contd)
(Technology) Regular consumption goods are produced from capital
stock (kt ) and labor (nt ) as Cobb-Douglas function, while housing
services are produced from the housing stock (ht ) directly:
yt = zkt nt1 + rt ht ,
where yt , z, rt denotes the time-t total output, total factor
productivity and the housing rental price in units of the consumption
good, respectively
Capital and housing stocks evolve according to
kt+1 = (1 k )kt + it , and
ht+1 = (1 h )ht + xt ,
where it and xt denote capital and housing investment
Finally, households face the budget constraints
ct + it + xt + rt ht yt
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 Solution

Solution
(Competitive Equilibrium) Solving for the households maximization
problem is not difficult, and any equilibrium path must satisfy:
(a) optimal labor (nt ) decision:
(1 )zkt nt ct = (1 )ht (1 nt ) ,
| {z } | {z }
marginal benefit from unit labor marginal harm from unit labor

(b) optimal capital investment (it ) decision:

ct = zkt+1
1 1


nt+1 + 1 k ct+1 ,
| {z }
marginal benefit from unit capital investment

(c) optimal housing investment (xt ) decision:

ct = ht+1
 1
(1 nt+1 )1+ + (1 h )ct+1

,
| {z }
marginal benefit from unit housing investment

(d) and the budget constraint:

ct + it + xt zkt nt1
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 Solution

Solution (contd)
(Asset Pricing) the period-t price for one unit of housing stock is

X
pt = (discounted sum of rt ) = h1 (1 n )+1 c
=t
Since no closed-form solution is available from this point on, I resort
to numerical methods with parameter values set tentatively as below:
Table: Parameter values
Parameter Description Value
Risk aversion in consumption 2
Relative importance of housing over leisure 0.5
Risk aversion in the housing-leisure aggregate 1.5
Relative importance of leisure over consumption 1
discount factor 0.95
z total factor productivity 1
share of capital 0.3
k Depreciation rate for capital 0.1
h Depreciation rate for houses 0.05

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 Solution

Solution (contd)
Among the many possible initial values k0 , h0 and their subsequent
equilibrium paths, the steady-state equilibrium in particular is the
easiest to compute directly from (a)-(d) and is given as
Table: Values of important variables at the steady-state equilibrium
Variable Value Variable Value
Output (y ) 1.17 Consumption (c ) 0.67
Capital stock (k ) 1.93 Capital investment (i ) 0.19
Housing stock (h ) 2.42 Housing investment (x ) 0.12
Labor (n ) 0.73 Wage (w ) 0.94
Unit house price (p ) 1.59 House rental price (r ) 0.08

In the meantime, the dynamics of equilibrium paths in general is

summarized by the decision rule g : (kt , ht ) 7 (kt+1 , ht+1 , nt ) that
solves the household maximization problem
I compute the approximate decision rule on the finite grids (11x11) and
(11x11x11) for the domain {kt , ht } and range {kt+1 , ht+1 , nt }
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 Solution

Solution (contd)

Definition
The recursive competitive equilibrium of this economy consists of the
rental prices (rt ), bond prices (qt ), the value function V (k, h) and the
decision rule (policy function) g(k, h) that solves the households problem

V (k, h) = max
0 0
u(c, h, 1 n) + V (k 0 , h0 )
k ,h ,n

given the prices (rt , qt ), subject to the technological and budget

constraints

This is equivalent to the infinite-horizon competitive equilibirum, and

it is something computers can easily solve
Start with a simple initial value function V0 (e.g. constant at zero) and
solve for g that maximizes the right hand side; iterate this on the new
value function V1 until the g converges such that Vi+1 Vi

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 Solution

Solution (contd)
For given values of the capital and housing stocks kt and ht , the
optimal responses in these two variables in the next period are:

If a given economy starts out with very low levels of both kinds of
stocks, it is optimal to invest mostly in capital first and in housing later
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 Solution

In the familiar phase-diagram format, it looks something like this:

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 Solution

Solution (contd)
Optimal labor decisions and the corresponding output are:

As an undercapitalized economy keeps investing heavily in capital,

leisure and output rise steeply but stop growing at one point, after
which it shifts towards housing investment
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 Solution

Solution (contd)
Other notable variables along the growth path are the savings rate
and the house rental price:

Savings rates are sharply reduced after sufficient capital is

accumulated; drops in house rental prices are even more dramatic
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 Discussion

Discussion
The presence of houses contribute to 1) an initial stage of fast
growth followed by 2) a sudden upward adjustment in leisure and
consumption rate as well as a sudden downward adjustment of
output growth and house (rental) prices
1) When an economy starts with little capital and housing, it saves almost
half of its income to invest in capital first so as to boost output while
households get low levels of leisure and consumption; house prices, in
the meantime, skyrocket as there are few houses available compared to
the steep capital and output growth
2) As capital accumulates and output reaches a certain level, households
enjoy greater leisure and greater consumption and as a result, they
start investing heavily in houses as well; output growth adjusts
downward as capital increase slows down, and house prices plummet as
more houses become available
This shift in growth patterns is in line with what many countries
experience although its speed and extent may differ by country
e.g. Japan in the 1980s, Korea in 1990s, US in 2000s and
China/worldwide recently
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 Summary

Summary

Houses, when they are leisure-complementing assets, are a crucial

source of changes in growth patterns
The presence of houses causes economies to experience major shifts
in leisure (), consumption (), output growth () and house
prices () after their initial growth phase

Outlook
The model is extremely simple and general, and thus can be easily
extended to apply to more specific settings: stochastic growth,
incomplete markets, heterogeneous agents, etc.
I might later try to compute the solution on a finer grid on a faster
computer (instead of my current $300 laptop)

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