Variation in Real Estate Prices and Macroeconomic Performance - Assignment Example

Variation in Real E Prices and Macroeconomic Performance As the economy of America keeps widening and picking up from the previous slump, prices of homes are increasing in many housing markets. The fall in the real estate prices is a major factor for the great destruction of wealth, which was a serious element of the previous economic depression. Various economic theories explain that the variation in real estate prices has key macroeconomic implications. There is clear evidence that house prices and macroeconomic factors are closely related.

Economic factors like inflation and income levels are key factors influencing the prices of houses. The performance of the housing sector significantly affects the general economy’s performance. Most theories, however, presume that it is only the macroeconomic factors that affect the variations in house prices and not the reverse. According to the vector autoregressive (VAR) model built by Baffoe - Bonnie, there are complete relations between the housing sector and the general economy (Case et al. 15). The theory asserts that macroeconomic variables usually cause cycles in the prices of houses and the number of houses sold.

If not brought to control, these effects may have adverse implications on the economy.Historically, changes in the prices of the real estate have been linked to changes in consumption in various ways. In the past, the slump in housing led to many empty houses and growing joblessness. Uncertainty about the consequences of declining home prices was also common in the past years. In the past - just like today, consumption or rather spending has been subject to people’s income. Economists Karl E.

Case, John M. Quigley and Robert J. Shiller made annual observations in 14 countries since the past 25 years and in some U.S. states quarterly in the 1980s and 1990s. Their observation was that some the future incomes were kept in the assets, stocks, bonds, and property, where most people keep their riches (Case et al. 15). A drop in asset values made many homeowners poorer, so they lowered their expenditure and raised savings. When the assets grew, they spent more. The theoretical arguments of the vector autoregressive (VAR) model are thus valid.

Economists have varying opinions on the consequences of varying house prices among the consumers. According to Carroll et al. (69), they disagree as to whether Americans will reduce their spending slowly or rapidly. On one side optimists, argue that the links between housing wealth and spending are much the same as for any other type of wealth, such as shares. They say peoples affluence rises with rising prices of houses. When house prices fall, consumers reduce their spending in a similar manner.

The optimists say the slowdown in housing has caused just a small effect on consumer expenditure. Pessimists on the other side say that it is because the weakening house prices would have a little and slow impact on consumer spending. They say low house prices will cause a big quick impact than the wealth effect. Despite the contention of opinions, no straightforward answer has been found. The available empirical evidence has not been able to settle the issues. The reason is that economists are getting it hard to neglect the wealth effect from housing empirically.

The two sides, however, agree that about $100 fall in assets is likely to lessen expenditure by about $3 to $5 every year (Carroll et al. 72). Research suggests that shifts in property values have in the past impacted spending, though not as much as the variations in share prices. In conclusion, the housing wealth in America today is having a greater influence on consumption compared to financial assets. The wealth effect due to housing is more important compared to the effect due to shares. The effect is fast increasing.

Works CitedCarroll, Christopher D., Misuzu Otsuka, and Jiri Slacalek, “How Large are Housing and Financial Wealth Effects? A New Approach” Journal of Money Credit and Banking (February 2011): 55-79. Case, Karl E., John M. Quigley, and Robert J. Shiller, “Comparing Wealth Effects: The StockMarket versus the Housing Market” Advances in Macroeconomics (Vol 5, Issue 1):1-34.