Evaluating Durable Public Good Provision using Housing Prices
Recent empirical work in public finance uses the housing price response to public investments to assess the efficiency of local durable public good provision. This paper investigates the theoretical foundations for this technique. In the context of a novel theoretical model developed to study the issue, it shows that there is little justification for the technique if citizens have rational expectations concerning future investment in their communities. An example in which investment is chosen by a budget-maximizing bureaucrat is developed to show why the technique can falsely predict under-provision. The technique is valid, however, when citizens have adaptive expectations, believing that whatever provision level that currently prevails will be maintained indefinitely.
I am grateful to Damon Clark and Jesse Rothstein for very helpful comments and to Gregory Besharov, Ross Milton, and Chris Timmins for useful discussions. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.