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The authors find that having a bubble in equity does not increase the probability that the recession is financial. However, when the bubble is in housing, the probability that the recession is financial increases. Finally, they analyze whether the economic effects of the crash of an equity bubble and a housing bubble are different. They document that the bursting of equity bubbles does not significantly increase the economic costs of recessions. However, the burst of housing bubbles has large and lasting negative economic effects. The crash of housing bubbles has an especially negative effect when the bubble goes hand in hand with excessive debt. For example, given their estimates, in this case, the GDP of the economy may still be 7.5% below the pre-recession level five years after the onset of the recession. To conclude, from this historical analysis we highlight three findings: (i) financial crises are worse than normal crises, (ii) housing bubbles are conducive to financial crises, and (iii) the bursting of housing bubbles exacerbates the economic costs of recessions. Therefore, if episodes of shortage of assets (or irrational exuberance) are recurrent over time and asset price bubbles are the natural response of financial markets, policymakers should guide investors so that the bubble is not attached to houses.
5.2 An Application: Misallocation in Spain This final section discusses the economic consequences of housing bubbles in the case of Spain. As discussed in Chapter 4, the recent housing bubble in Spain was very large by international standards (see also Fig. 4.1). For example, the cumulative average growth rate of real house prices in Spain between 2002 and 2007 (the peak) was 11%. In contrast, the average growth rate between 2002 and 2006 in the United States was just 6%. Another metric to compare the size of the two bubbles is the peak-to-bottom change in real house prices. In Spain, the fall in real house prices was 42%, whereas in the United States the fall was 27%. We have emphasized in the previous section the usefulness of considering municipalities to assess the effects of the housing bubble. Basco and Lopez-Rodriguez (2018) built a house price index for all municipalities in Spain between 2004 and 2007. In addition, they developed a measure of land availability based on the housing supply elasticity of
