Kaiji Chen and Yi Wen
CQER Working Paper 15-03
November 2015
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China's housing prices have been growing nearly twice as fast as national income in the past decade despite (1) a phenomenal rate of return to capital and (2) an alarmingly high vacancy rate. This paper interprets such a prolonged paradoxical housing boom as a rational bubble that emerges naturally from China's large-scale economic transition, featuring an exceptionally high rate of return to capital driven by massive resource reallocation. Because such primarily resource-reallocation-driven high capital returns are not sustainable in the long run, expectations of high future demand for alternative stores of value can induce even the currently most productive agents to speculate in the housing market, even if housing provides no rents or utilities. We show that such speculative investment behavior can create a self-fulfilling housing bubble that grows much faster than the national income during an economic transition, thus explaining China's massive "ghost apartment" phenomenon and decade-long faster-than-income growth in housing prices despite high capital returns.
JEL classification: E22, E23, O11, O16, P23, P24, R31
Key words: housing bubble, resource misallocation, Chinese economy, development, economic transition
The authors thank Xiangyu Gong, Xin Wang, and Tong Xu for capable research assistance; Jing Wu for sharing data on China's housing prices; and Suqin Ge and Dennis Tao Yang for sharing data on China's real wage rate. Thank you to Toni Braun, Satyajit Chatterjee, YiLi Chien, Carlos Garriga, Lee Ohanian, B. Ravikumar, Richard Rogerson, Manuel Santos, Zheng Song, Kjetil Storesletten, Gian Luca Violante, Yikai Wang, Tao Zha, and the participants of Brown Bag Seminar at the Federal Reserve Bank of St. Louis; 2013 Tsinghua Macro Workshop; 2013 Shanghai Macro Workshop; 2014 Spring Housing-Urban-Labor-Macro (HULM) conference; and the 2014 Northwestern-SAIF Conference in Macroeconomic Policies and Business Cycles for helpful comments. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Kaiji Chen, Economics Department, Emory University, and Research Department of Federal Reserve Bank of Atlanta, Rich Memorial Building, Room 306,
Atlanta, Georgia 30322-2240, 404-727-2944, kaiji.chen@emory.edu or Yi Wen, School of Economics and Management, Tsinghua University, and Research Division, Federal Reserve Bank of St. Louis, Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166-0442, 314-444-8559, yi.wen@stls.frb.org
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