NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

House Prices and Consumer Spending

David Berger, Veronica Guerrieri, Guido Lorenzoni, Joseph Vavra

NBER Working Paper No. 21667
Issued in October 2015, Revised in August 2017
NBER Program(s):Corporate Finance, Economic Fluctuations and Growth, Labor Studies, Monetary Economics, Public Economics

Recent empirical work shows large consumption responses to house price movements. This is at odds with a prominent theoretical view which, using the logic of the permanent income hypothesis, argues that consumption responses should be small. We show that, in contrast to this view, workhorse models of consumption with incomplete markets calibrated to rich cross-sectional micro facts actually predict large consumption responses, in line with the data. To explain this result, we show that consumption responses to permanent house price shocks can be approximated by a simple and robust rule-of-thumb formula: the marginal propensity to consume out of temporary income times the value of housing. In our model, consumption responses depend on a number of factors such as the level and distribution of debt, the size and history of house price shocks, and the level of credit supply. Each of these effects is naturally explained with our simple formula.

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Document Object Identifier (DOI): 10.3386/w21667

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