Abstract
This paper studies the interaction between inequality and house prices using an incomplete market heterogeneous agent model. The model links cross-sectional household portfolio saving decisions to housing market outcomes. It illustrates a new price formation mechanism in which the investment motive among the wealthy plays a key role. A quantitative application of the theory rationalizes puzzling phenomena in China — notably, the recent substantial housing boom accompanied by rising savings rates. The theory in this paper shows that market frictions can have differential impacts cross-sectionally, increasing inequality. Inequality can in turn amplify frictions in the market. This adds to our understanding of how inequality and macroeconomic forces can interact.
JEL Codes: E21, G11, O16, O18, P22, R21.
Keywords: housing, inequality, Chinese economy.
