The financial sector and crises - The housing feedback process and the 3-equation model

4 important questions on The financial sector and crises - The housing feedback process and the 3-equation model

Describe the impact of long-run supply constraints on the formation of house price bubbles

Figure 6.8

Why would it be reasonable to infer that a bubble is underway if one observed steeply rising house prices?

If the long-run supply curve is flat, house prices must eventually fall to the level consistent with that supply curve. In this setting, ever-increasing house prices must be explained by extrapolative expectations driving a bubble process.

How can a house-price based boom turn into a financial crisis?

1. When a property bubble bursts and house prices fall, the net worth of households falls and some households are unable to service their mortgage.
2. Houses are repossessed by the bank and sold at a loss.
3. The net worth of banks falls due to the losses they incur on mortgage loans.
4. A bank can become insolvent: the shrinkage of the value of its assets wipes out its capital cushion.
  • Higher grades + faster learning
  • Never study anything twice
  • 100% sure, 100% understanding
Discover Study Smart

Describe the link between the housing feedback process and the 3-equation model

A rightwards shift of the IS curve will push up inflation and lead to a tightening of monetary policy.
Figure 6.9

The question on the page originate from the summary of the following study material:

  • A unique study and practice tool
  • Never study anything twice again
  • Get the grades you hope for
  • 100% sure, 100% understanding
Remember faster, study better. Scientifically proven.
Trustpilot Logo