More on Beveridge Curve: Disequilibrium and Oversupply in the Housing Market

Earlier I posted on some research that I was working on about a Beveridge curve in the housing market (the work that motivates the name of this blog). The working paper version of the paper is now finished and available for downloading.

The main results of the paper:

• The Beveridge Curve represents a long-run supply condition
• Short run deviations represent periods of disequilibrium, either over or under supply
• Using a years of oversupply metric, the observation of 2007-2008 was an all-time high of 0.995 years of oversupply, more than three times the previous peak of 0.285 in 1973-1974.

Results regarding the differences between the owner-occupied and rental markets:

• Generally, oversupply is a phenomena in the rental market
• Oversupply in the rental market is twice as volatile as in the owner-occupied market
• Oversupply first shows up in the rental market

Last, I find that

• Oversupply in the owner-occupied market is related to house prices, reinforcing the idea that short run deviations in house prices from fundamentals (such as bubbles) can lead to periods of oversupply

Below, I give a summary of these results, except for the last bullet on house prices which I leave to another post.

The primary change from the earlier results is that instead of doing the fairly ad-hoc HP filter, I have gone ahead and estimated the model using biannual data. In my opinion this gives a better estimation. In addition to the new estimation I have also found some interesting results relating oversupply of houses to house prices. I will go over those results in my next entry, for now I give an overview of my previous results under the new estimation.

The main idea of the Beveridge curve is that it represents the long-run equilibrium in the housing market. The Beveridge curve has its origins in labour economics, where Lord Beveridge found a negative relationship between the unemployment rate and the amount of job vacancies. For an example, see Rob Shimer's website. In the housing market I have found a negative relationship between the rate of household formation and the residential vacancy rate. I deem this negative relationship the Beveridge curve in the housing market. The Beveridge curve relationship exists in the owner-occupied market, the rental market, and the overall market irrsepective of ownership. Figure 4 from the paper, shown here below, shows the relationship for the overall house market. There is a clear and statistically significant negative relationship and the R-squared from a linear regression is 0.626.

As I stated, the curve represents a long-run relationship, so that short-run deviations (two to four years) represent periods of disequilibrium in the housing market, these are periods of under or over supply, see figure 7 below.
The next figure shows the estimated time-series of oversupply for the total housing market irrespective of home-ownership. The metric of oversupply is in a % of the total housing stock. Here we clearly see three periods of oversupply since the start of the data in 1968: (1) the 1974 crisis; (2) the mid to late 1980s housing boom; and (3) the current crisis. The oversupply in the current crisis is similar in magnitude to the 1974 crisis, with both having an oversupply of just under 1% of the total housing stock.
However, the rate of household formation is much lower now, so that it may take much longer to work off the oversupply. The next figure plots the estimate of oversupply in years of oversupply. This is the oversupply in years of household formation. For instance, if the rate of household formation was 1% and the oversupply of the housing stock was 1%, then it would take one year of no housing production for the oversupply to disappear. Using this metric, the amount of oversupply is staggering, being about one year of supply in 2007-2008 compared to under 0.3 years in the 1974 crisis.

One point that I cannot stress enough is that what we are currently facing is a huge oversupply of housing, irrespective of whether it is rental or owner-occupied housing. As I stated in the earlier post there is actually more oversupply in the rental market. To see this, below is figure 12 from the paper. The metric is years of oversupply in terms of the total rate of household formation, so that we are comparing apples to apples. There are several striking features in this figure:

• Generally, oversupply is a phenomena in the rental market
• Oversupply in the rental market is twice as volatile as in the owner-occupied market
• Oversupply first shows up in the rental market

These results suggest that the rental market is sponge the soaks up oversupply in periods of overall oversupply, and then lets it out once housing becomes relatively scarce. This suggests that research on the housing market, especially empirical, needs to include data from the rental market when doing structural work.