Abstract
The recent housing cycle in the United States saw a large swing not only in home prices but in the number of home sales as well. This paper begins by using a comprehensive dataset on US home sales to investigate two popular explanations for the cyclicality of selling activity: “house lock,” which conjectures that falling prices cause down-payment constraints to bind and prevent current homeowners from selling their homes; and nominal loss aversion, which proposes that cognitive frictions prevent homeowners from selling when doing so would not garner a price as high as the one they originally paid for the house. I find that while there is evidence that both of these mechanisms are active at the household level, they explain a fairly small portion of the decline in sales from boom to bust: likely no more than 10%. I then propose a novel mechanism, which is that construction of New homes, which tend to be of high quality, unlocks sales of Existing homes during booms, as there is aggregate movement up the housing ladder. In the bust, this movement freezes, and it does not reverse, as the irreversibility of construction prevents the market from tearing down nice homes and facilitating an aggregate down-size. As a result, sales are high in the boom and low in the bust. I show that the model’s predictions are consistent with recent dynamics of aggregate prices and volume, as well as cross-MSA variation in sales. Overall, the model is able to explain up to 30% of the aggregate movements in sales over the previous cycle. I conclude by discussing factors that could increase or decrease this magnitude.