Abstract
This paper revives the debate in the literature about the relationship between house prices and consumption by exploring conflicting results in the UK. Campbell and Cocco () find that old owners benefit most from a house price increase and young renters least, confirming the so‐called wealth hypothesis. In contrast, Attanasio et al. () find that house prices have the same impact on consumption across age groups. We rule out several potential explanations related to data construction, and provide evidence that the functional form can reconcile the conflicting results in the two papers.
Highlights
This paper looks at the validity of the wealth and the common factor hypotheses as alternative explanations to the relationship between changes in house prices and consumption in the UK
These findings are analogous to those in Browning, Deaton, and Irish (1985) and suggests that the year to year changes within cohorts captured by the Euler equation specification used by CC, differ from the life cycle variation across cohorts captured by the levels specification used by ABHL
The level of house prices explains consumption over the life-cycle, the coefficients are remarkably similar for the three age groups considered
Summary
This paper looks at the validity of the wealth and the common factor hypotheses as alternative explanations to the relationship between changes in house prices and consumption in the UK. The wealth hypothesis suggests that rising house prices stimulate consumption by increasing households’ perceived wealth. The common factor hypothesis supports the fact that both, rises in house prices and consumption, are driven by common factors. Housing is the dominant component of wealth for the typical household in the United Kingdom. Banks and Tanner (2002) report that real estate accounted for 35% of aggregate household wealth in the UK in the mid 1990s, and more recent estimates suggest that in 2006-08 this figure rose to 39% (e.g., ONS 2009). House prices exhibit high levels of volatility, especially in the UK. Nominal house prices ranged from -10% to 30% between 1988 and 2000 (e.g., Campbell and Cocco 2007). Given the drop in nominal house prices during the last economic crisis (www.nationwide.co.uk), understanding whether house prices affect consumption, and if so, the nature of this relationship, is crucially important
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