Question

Assume that in France and Germany, it is not possible for a household to increase its borrowing based on an increase in the market value of their house. In addition, a large down-payment (as a percentage of the house price) is required to purchase a house. On the basis of this information, which of the following statements is correct when there is a rise in housing prices?

Select one answer:
a) There is a positive financial accelerator effect for the existing homeowners who are credit-constrained.
b) Would-be homeowners would increase saving and reduce consumption.
c) A rise in housing prices leads to an increase in human capital.
d) A rise in housing prices is likely to lead to an increase in consumption in France and Germany.

Answer 1

The rise in housing prices in France and Germany, given the inability to borrow against home equity and the requirement for large down payments, b) would induce would-be homeowners to save more and consume less.

Step-by-step explanation:

When there is a rise in housing prices in France and Germany, the correct statement considering the given conditions is that would-be homeowners would increase saving and reduce consumption. This is because households are unable to increase their borrowing based on increased house values and a large down payment is required. In such a scenario, there isn't a positive financial accelerator effect for existing homeowners since they are credit-constrained. Additionally, a rise in housing prices does not directly lead to an increase in human capital or an increase in consumption, as the assumption is that housing equity cannot serve as collateral for consumption loans.

Changes in housing prices can have various effects on the economy:

• If the number of people at the most common ages for home-buying increases, demand for homes may rise, potentially increasing prices if supply doesn't keep up.
• Increased confidence in economic growth and job security often results in more willingness to purchase homes, positively affecting demand.
• Banks finding that more people are defaulting on loans may lead to tighter lending standards and decreased supply of home loans.