How Do Housing Prices Affect Consumption
The standard story is that an increase in the price of a house is a wealth increase for the household, and hence will lead to an increase in consumption. However, there are a couple of reasons to think this might not be the case. The first is that there is no real theoretical justification for this. If the price of the house goes up, the only way for the household to enjoy additional consumption is to consume less “housing services”–i.e. sell the current house and move into a cheaper house. The homeowner who does not do this is basically paying a higher implicit rental cost of housing. The other reason why consumption may be positively correlated to housing prices is that an increase in the price of the house may allow borrowing constrained households to smooth out consumption over the life cycle via a loan. What the loan accomplishes is to allow the household to borrow from future consumption today. That is, suppose the household is constrained in terms of borrowing. Then the house price increases by say $100,000. This could allow the household to borrow against this future consumption (when the household sells the house several years or decades hence) and consume it today.
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 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.