House Prices, Consumption, Wealth Effects and Policy
by Ken Gibb
The precise relationship between house prices, wealth effects and consumption, as George Osborne hinted when he introduced the notorious Help to Buy policy, is a bit complex.
In an intriguing blog on the LSE’s EUROPP site, re-posted on the Pieria site (1), an academic team (Browning, Gortz and Leth-Peterson) has re-engaged with this debate looking at Danish data from 1987-96. They focus on equity withdrawal (consumption loans secured by housing equity collateral) and distinguish between older and younger home-owners. They believe that their data supports the income expectations perspective on these questions: higher future expected income leads people to increase spending and thus bid more for housing pushing up house prices. So, rather than house prices driving consumption, the causality is quite different (i.e. both are led by a third factor – expectations of earnings).
This is important because it suggests that policy aimed at pushing up house prices might not have the desired consumption and aggregate demand impacts on economic growth. The authors of the paper/blog argue that their evidence suggests that in particular older owners are consumption-insensitive to house price increases but younger households use the fact of increased housing equity as a means of a degree of credit expansion for consumption (non-housing) loans.
Interesting stuff. I should say that while I have not yet read their full paper in the Economic Journal (2), and though I have a degree of sympathy with the intuition of this analysis, a few questions should be aired before getting into the wider debate about the issue.
The authors point out there is considerable controversy about the relationship between house prices, housing wealth and consumption. In our 2012 paper in Housing Studies (3), Tony O’Sullivan and I retraced the academic controversy. There is as much disagreement about the theoretical relationships, as there is about the data and what is tells us. For instance, those who think that income expectations drive consumption indicate that the effect varies over time and the market cycle. Others argue that short-run speculative factors are important in determining house prices (and their fundamental determination does logically comes first).
There must also be questions about the transferability of this micro panel data analysis to the UK. Is Denmark sufficiently similar, for instance, as the UK in institutional, lending, housing market and welfare regime terms, and in the context of the 1980s and 1990s – well before the unusual financial context prevailing since 2007-08? Also, is the issue solely captured by consumption loans based on housing equity? For those who are not liquidity constrained, consumption may rise in the knowledge of rising housing equity, savings fall, because they feel wealthier, but without necessarily taking out a loan – but unfortunately this kind of wealth effect is harder to measure. A fascinating question is also how these people respond to falling prices, equity and income expectations (a question addressed in the behavioural economics literature) (4)?
The policy debate that emerges from this paper is incredibly contemporary. In our paper in 2012 we noted the ambivalence of the Government’s economic view of the transmission mechanism: the Bank of England stated it did not believe in a relationship where house prices impact on consumption though earlier Treasury work relating to the conditions for joining the Euro did make this connection. In 2013, it is hard not to conclude that HM Treasury now thinks that the underwriting of borrowing by moving purchasers can both support the economy and ultimately stimulate all the good GDP-enhancing aspects of increased transactions and confidence, more supply (possibly) and feel-good wealth effects on broader consumption. And, I would suggest, they do not fully consider or engage with the consequences of possible bubbles and other bad things that might also follow.
The interesting new research on Denmark’s home-owners suggests that the transmission mechanism is less strong than is often suggested. These findings may or may not be transferable to the contemporary UK in economic recovery mode. Nonetheless, there remains a remarkable disconnect between government macroeconomic hope and aspiration, beliefs about how important specific sectors like housing actually impact on the economy, and the absence of long term stability-based policies which seek to neutralize or normalise the impact and wider effects of the housing sector. We have had 25 years or so of research and data on housing’s relationship with the economy post deregulation – yet we remain in the dark about key parts of this vital relationship and can only conclude that policymakers should be cautious about the assumptions they make and beliefs they hold about how this plays out.
(1) Rising house prices don’t tend to fuel greater consumption by households (Martin Browning, Mette Gortz and Soren Leth-Peterson) in: http://www.pieria.co.uk/articles/rising_house_prices_dont_tend_to_fuel_greater_consumption_by_households
(2) ‘Housing wealth and consumption: a micro panel study’, Economic Journal, Vol.123, pp. 401-28.
(3) O’Sullivan, A and Gibb, K (2012) ‘Housing Taxation and the Economic Benefits of Home Ownership’, Housing Studies, Vol.27 (2), pp. 267-79.
(4) See, for instance: Wilkinson, N (2008) An Introduction to Behavioural Economics. Palgrave Macmillan: Basingstoke.