The housing wealth effect on consumption reconsidered

Fabian Lindner

No 2014-15, Economics Discussion Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: Much of the literature on the effect of housing wealth on consumption has been embedded in a simple life-cycle model in which housing price changes work as a wealth effect. In such models, windfall gains in housing always lead to positive changes in consumption. However, this might constitute a fallacy of composition. Such models ignore that changes in housing wealth have distributional consequences between those planning to sell their house and those planning to buy a house. Further, since most housing is not simply financed out of current cash holdings but by mortgages, the institutions on mortgage markets have to be considered when looking at the wealth effect of housing. In this paper, a model is presented from which the classic Ando-Modigliani consumption function augmented by housing wealth can be deduced. It is shown that the deeper structural model from which this equation is deduced implies that changes in housing wealth are not necessarily positively correlated with consumption. It will be argued that changes both in demographics (the composition of the age groups in the population) as well as in mortgage markets have led to a structural break in the effect of housing wealth on consumption in the mid-1980s in the US. In the empirical part of the paper, two VAR models are estimated and impulse-response functions are computed. The results show that housing wealth changes did affect consumption differently before the mid-1980s and afterward. While both models show that consumption was positively related to housing wealth shocks after the mid-1980s, there was no or even a negative relation before.

Keywords: housing; consumption; wealth effect; demographics; mortgage markets (search for similar items in EconPapers)
JEL-codes: C32 E21 E44 R31 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-mac and nep-ure
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Citations: View citations in EconPapers (2)

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https://www.econstor.eu/bitstream/10419/95912/1/782400086.pdf (application/pdf)

Related works:
Working Paper: The Housing Wealth Effect on Consumption Reconsidered (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwedp:201415

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