We have suggested in the text that the rapid rise in housing prices in the period from

Question:

We have suggested in the text that the rapid rise in housing prices in the period from 2000 to 2006 and the subsequent rapid fall of those prices after 2006 may have played a role in the 2008–2009 recession. There has been a good deal of work in economics tracing the links between what has been called the housing bubble and that recession, particularly on the bursting of the bubble on bank stability.

But how do we measure housing price changes? After all, houses are all different. Measuring price changes in houses is much harder than measuring price changes in oil, or even price changes in milk or cans of tuna fish. One possibility is to look at changes in the average price of a house in a city over time. However, if in year one mostly modest split-levels change hands, while in year two most of the houses sold are McMansions, then changes in the average price will not do a very good job of capturing housing price inflation. An alternative is to try to standardize the house type, say looking at the change in the average price of a four-bedroom house in an area over time. This is better, but still leaves one with a lot of heterogeneity. In fact, one of the authors of this text, Karl Case, working with Robert Shiller, a behavioral finance economist, developed an index (aptly named the Case-Shiller index) that neatly solves the problem that houses are all different.

The Case-Shiller index looks only at houses that have sold multiple times and asks the question: How much does an identical house sell for now versus that same house in the past? The index, developed first in Boston, is now computed for a number of large housing areas. In fact, the index itself is commonly reported on the financial pages and shows housing price changes for 10-city and 20-city bundles. So what does the Case-Shiller index tell us about the present? From 1996 to 2006, the Case-Shiller index increased by 125 percent, only to fall by 38 percent from 2006 to 2011. 2012 and early 2013 looked much better, with an annual increase of 7.3 percent in the 10-city index and 8.1 percent for the 20-city index as of April 2013.

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