NCPA - National Center for Policy Analysis


May 2, 2006

Houses -- the dominant component of wealth for a typical household in the United States and the United Kingdom -- are risky assets with volatile prices, leading many to suggest that house-price changes have significant effects on aggregate consumption, says Les Picker of the National Bureau of Economic Research (NBER).

Even though it is tempting to attribute the correlation between house prices and consumption to a direct housing wealth effect, there are several reasons not to make this attribution, says Picker:

  • 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, and homeowners who remain in their houses over the long term simply pay a higher implicit rental cost.
  • A house can be used as collateral in a loan, and an increase in house price may allow borrowing constrained homeowners to smooth consumption over the life cycle.

Moreover, a study using micro-level data from the United Kingdom Family Expenditure Survey helps distinguish among these alternative explanations. According to researchers:

  • Older homeowners and younger renters represent households that are most likely to gain and lose from house price increases.
  • A large positive effect of house prices on consumption for older homeowners was estimated, as was an effect that is close to zero for renters.
  • Regional house prices do influence regional consumption, proving that it's important to allow for regional heterogeneity when estimating the effects of house prices on consumption.
  • Consumption also responds to predictable changes in house prices.Furthermore, these findings suggest that aggregate consumption may become more responsive to house prices as older homeowners become an increasing fraction of the population; in fact, in recent years, this has occurred in both the United States and the United Kingdom, says Picker.

Source: Les Picker, "How Do House Prices Affect Consumption?" NBER Digest, February 2006; based upon: John Campbell and João Cocco, "How Do House Prices Affect Consumption? Evidence From Micro Data," NBER Working Paper, no. 11534, August 2005.

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