How Do House Prices Affect Consumption?

"Aggregate consumption may become more responsive to house prices as older homeowners become an increasing fraction of the population."

Housing is the dominant component of wealth for the typical household in the United States or the United Kingdom, with residential property accounting for about 25 percent of aggregate household wealth in the United States in the late 1990s and for 35 percent of aggregate household wealth in the United Kingdom in the mid-1990s.

Houses are risky assets with volatile prices. Much of this volatility is local, but a common component of house prices is visible in regional and even in national house-price indexes. National house-price volatility is particularly striking in the United Kingdom, a geographically compact country with a nationally integrated housing market. The magnitude and volatility of housing wealth have led many to suggest that house-price changes have significant effects on aggregate consumption.

It is tempting to attribute the correlation between house prices and consumption to a direct housing wealth effect: increasing house prices increase homeowners' wealth, which in turn increases consumption. There are, however, several reasons not to make this attribution without further analysis. First, the theoretical rationale for a large housing wealth effect is unclear. When house prices rise, homeowners can only increase their consumption if they reduce their consumption of housing services; homeowners who remain in their houses over the long term simply pay a higher implicit rental cost of housing. Second, there are alternative explanations for the correlation between house prices and consumption. A house is an asset that can be used as collateral in a loan. An increase in house prices may allow borrowing constrained homeowners to smooth consumption over the life cycle. The correlation between house prices and consumption may also be driven by an unobserved macroeconomic factor.

In How Do House Prices Affect Consumption? Evidence From Micro Data (NBER Working Paper No. 11534), authors John Campbell and João Cocco use micro-level data from the U.K. Family Expenditure Survey to distinguish among these alternative explanations. Micro data can be helpful because they allow the authors to identify those households for which the direct wealth effect of house prices is particularly large or small. Older homeowners and younger renters represent households that are most likely to gain and lose from house price increases. Consistent with a direct wealth effect, the authors estimate a large positive effect of house prices on consumption for the cohort of old households who are homeowners, and an effect that is close to zero for the cohort of young households who are renters.

The authors also find that, controlling for economy-wide house prices and for regional income, regional house prices do influence regional consumption. This is a key result for policymakers and economists, showing that it is important to allow for regional heterogeneity when estimating the effects of house prices on consumption.

Finally, the authors find that consumption responds to predictable changes in house prices, consistent with the idea that an increase in house prices relaxes borrowing constraints. The consumption effects of predictable changes in house prices appear to be weaker for households that have unused borrowing capacity, but they affect both renters and homeowners. This suggests that U.K. house prices are related to the ease or difficulty of borrowing in the economy as a whole.

The findings of this study have macroeconomic implications because they suggest that aggregate consumption may become more responsive to house prices as older homeowners become an increasing fraction of the population. In recent years, both the United Kingdom and the United States have experienced rising property prices and strong private consumption, pointing to the relevance of the authors' estimates

-- Les Picker

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