Abstract
This paper undertakes a comparison exercise to disentangle what drives the opposite findings regarding the effect of house prices on consumption documented in two papers using the same data set for the UK. On the one hand, Campbell and Cocco (2007) find that old owners are the most benefited by a house price increase and young renters the least, confirming the so-called wealth hypothesis. On the other hand, Attanasio, Blow, Hamilton, and Leicester (2009) find that house prices have the same impact on consumption across age groups, consistent with the so-called common factor hypothesis. First, we confirm that the findings in both papers can be reproduced. Second, we rule out a number of potential reasons related to the basic data construction, and provide evidence that the functional form (i.e., an Euler equation of consumption vs. a reduced form life-cycle model) and not data aggregation considerations (household level data vs. synthetic cohort data) may be at the root of the conflicting results in the two papers. Our findings revive the debate of whether there is an effect of house prices on consumption.
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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