June 29, 2009
June 29, 2009
Some friends have been debating the role of housing prices in consumer spending, stimulated by two recent articles in the Wall Street Journal’s Real Time Economics blog. First, Charles Calomiris, Stanley Longhofer and William Miles wrote that effect of housing wealth on consumption is about zero. Then, Atif Mian and Amir Sufi of the University of Chicago offered a differing view.
I am very cautious before throwing out conclusions that have been tested in multiple ways over many years. The wealth effect on consumption has been studied since the 1930s, with fairly consistent findings of low elasticity (one to three percent is common).
I quickly scanned some macro-econometric books on my shelf (Michael Evans, Macroeconomic Activity, 1969; Otto Eckstein, The DRI Model of the U.S. Economy, 1983, and Ray Fair, Estimating How the Macroeconomy Works, 2004). All these guys, very familiar with past research and deeply hands-on in their own model development, have negligible to low wealth elasticities in their models. Their work also spans several decades.
We must differentiate an actual wealth elasticity from the method of funding consumption. A person who chose to increase consumer spending and who was acting in accordance with a mainstream consumption function might well have used home equity financing so heavily that it looked like it was housing wealth that enabled consumption. That’s because mortgage finance was a cheaper (especially net of taxes) way to fund car purchases than car loans. Also cheaper to use an HEQ or cash-out refi to buy furniture or take a vacation than run a high balance on credit cards. In addition, many consumers consciously leveraged up their balance sheets: lots of mortgage debt to fund investments, not just consumption.
Mian and Sufi’s most interesting conclusion is:
“… the effect of house prices on homeowner borrowing is isolated to homeowners with low credit scores and high credit card utilization rates.”
It surprising that they find such a large macro effect from this one segment of consumers. If they are right, here’s the interpretation I’d give: normally housing wealth has a negligible effect on consumption. Then for a few years it had an unusually positive effect, as it allowed otherwise credit-constrained families to spend more. But now that’s over and we’re back to normal The transition back to normal is tough, but we will resume the old fashioned consumption function. However, the Calomiris et al research disputes this view. It’s quite possible that their analysis, which covers a large swath of post World War II economic history, misses the Mian and Sufi effect because it wasn’t just housing prices that stimulated consumer spending, but the combination of rising housing prices and readily available sub-prime debt.
In any event, I think we’re headed back to a normal relationship now. Consumer spending will move independently of housing price changes in the future.
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