House price fluctuations and residential sorting

Empirical evidence suggests that local jurisdictions are internally more heterogeneous than standard sorting models predict. We develop a dynamic multi-region model, with fluctuating regional house prices, where an owner-occupying household’s location choice depends on its current wealth and its current ‘match’ and involves both consumption and investment considerations. The relative weights of the consumption and investment motives in the location choice determine the equilibrium pattern of residential sorting, with a strong investment (consumption) motive implying sorting according to match (wealth). The model predicts a negative relation between size of house price fluctuations and residential sorting in the match dimension. Also movers should be more sorted than stayers. These predictions are consistent with evidence from US metropolitan areas when income, age and education are used as proxies for the match.

Introduction: New hires and continuing jobs exhibit substantially differing productivity and wage dynamics as well as job separation behavior. Whereas it is well known that productivity and wages increase with tenure (eg Brown, 1989, Topel, 1991) and that the probability of a job ending declines with tenure (eg Farber, 1999), the differing wage cyclicality of new hires and continuing jobs has been the focus of attention in recent labour market matching literature.Haefke et al (2008) and Carneiro et al (2008) provide evidence on the strong responsiveness of wages in new hires to productivity fluctuations, whereas wages of continuing jobs exhibit substantial rigidity. Pissarides (2008) surveys the empirical evidence about the cyclicality of wages in new and continuing jobs and relates the evidence to the discussion of the ‘unemployment volatility puzzle’ in the Mortensen-Pissarides matching model. He argues that the observed cyclicality of wages of new matches is consistent with the Nash wage equation, which gives a proportional relationship between wages and labour productivity, in the standard Mortensen-Pissarides model. Furthermore, he argues that given the weak empirical support for wage stickiness, plausible explanations of the unemployment volatility puzzle should not rely on a sticky wage, but should rather be consistent with the observed proportional relation between labor productivity and wages of new matches.

Author: Markus Haavio,Heikki Kauppi

Source: Research Discussion Papers, Bank of Finland

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