Land Speculation and Wobbly Dynamics with Endogenous Phase Transitions: A Macroeconomic Model with Rational Exuberance

The Institute of Economics will hold a seminar meeting as part of its Seminar Series on Tuesday, April 19, 2022: Tomohiro Hirano from the Royal Holloway University of London, the Center for Macroeconomics at the LSE, and the Canon Institute for Global Studies, will present the paper "Land Speculation and Wobbly Dynamics with Endogenous Phase Transitions: A Macroeconomic Model with Rational Exuberance".

Abstract:

This paper examines the global macro-dynamics of a dynamic model with capital and land with rational expectations. There are a plethora of rational expectation equilibria trajectories driven by people’s beliefs; land prices and other key macro variables endogenously wobble within well-identified ranges with repeated boom-bust cycles. The key to understanding wobbly fluctuations with land speculation is that through the interactions between land prices and capital accumulation, the state of macro-economy changes endogenously between stable and unstable states—what we call phase transitions. When land prices are low, the unique momentary equilibrium entails bullish expectations. Land prices rise, and this increase in land prices accelerates, and therefore looks explosive. Moreover, the real estate boom crowds out productive investment. While the boom is not sustainable, the temporary “exuberance” is still fully consistent with rational expectations. Once land prices pass a critical level, there is a phase transition. The macroeconomic system endogenously enters into an unstable state where bullish expectations can suddenly change into bearish, so land prices can collapse at any time. Macroeconomic instabilities suddenly arise. If land prices do not collapse, when they exceed a still higher critical threshold, there is another phase transition. This is the tipping point when land speculation reaches an unsustainable level, and bullish expectations suddenly must turn bearish, leading to endogenous crashes. We analyze the set of parameter values for which wobbly fluctuations occur, demonstrate how changes in parameters affect global macro-dynamics, and show how policy interventions can affect stability and social welfare.

A draft is available here.

The seminar will be held online. For online please use the following link.