How Large Is the Housing Wealth Effect? A New Approach

Abstract

This paper presents a simple new method for estimating the size of 'wealth effects' on aggregate consumption. The method exploits the well-documented sluggishness of consumption growth (often interpreted as 'habits' in the asset pricing literature) to distinguish between short-run and long-run wealth effects. In U.S. data, we estimate that the immediate (next-quarter) marginal propensity to consume from a $1 change in housing wealth is about 2 cents, with a final long-run effect around 9 cents. Consistent with several recent studies, we find a housing wealth effect that is substantially larger than the stock wealth effect. We believe that our approach is preferable to the currently popular cointegration-based estimation methods, because neither theory nor evidence justifies faith in the existence of a stable cointegrating vector.

The long run relationship between private consumption and wealth: common and idiosyncratic effects

“…In other studies, stock market wealth shows the larger impact (Dvornak andKohler, 2003 andDe Veir-man andDunstan, 2008). Ludwig and Slok (2004) and Carroll, Otsuka and Slacalek (2006) have emphasized that the long-run responsiveness of consumption to permanent changes in wealth depends on the institutional framework. In particular, the wealth effect is higher for countries with a market-based than for countries with a bank-based financial system.…”

US inflation and consumption: A long-term perspective with a level shift

“…The problem with the cointegration method is that it implicitly requires the existence of a stable long term relationship between consumption, income and wealth. However, in our sample of 50 years, there have been major changes in the structure of the economy due to changes in tax structure, demographics, productivity growth, financial structure, social insurance, and many other aspects of the economy (Carroll et al, 2006). Therefore, as Carroll et al (2006) noted, trying to find the existence of a cointegrating relationship which satisfies the condition of stability is problematic.…”

“…However, in our sample of 50 years, there have been major changes in the structure of the economy due to changes in tax structure, demographics, productivity growth, financial structure, social insurance, and many other aspects of the economy (Carroll et al, 2006). Therefore, as Carroll et al (2006) noted, trying to find the existence of a cointegrating relationship which satisfies the condition of stability is problematic. They criticized the idea long-run relationship and estimated the marginal propensity to consume (MPC) out of wealth with alternative methods.…”

“…3 This study showed that there is no cointegration if the criteria for significance are not extended to over 10% of the critical values. Carroll et al (2006) were skeptical about the possibility of finding a stable cointegration relationship. They point out that changes in demographic factors and financial system may have caused a break in the consumption function.…”

An Early Warning System to Predict the House Price Bubbles

“…For example, Almeida et al (2006) have reported evidence that the sensitivity of house prices and mortgage borrowings to income shocks is higher in countries with higher loan-to-value ratios. Ludwig and Sløk (2004) and Carroll et al (2006) have emphasized that the long-run responsiveness of consumption to permanent changes in housing wealth is higher for countries with a market-based than for countries with a bank-based financial system. According to Catte et al (2004), strong impacts of real house prices on consumption can be detected especially in countries that have large, efficient and responsive mortgage markets.…”