Abstract

Abstract A fall in house prices due to a change in fundamental value redistributes wealth from those long housing (for whom the fundamental value of the house they own exceeds the present discounted value of their planned future consumption of housing services) to those short housing. In a closed economy representative agent model (the special case when the birth rate is zero, of the Yaari-Blanchard OLG model used in the paper), there is no pure wealth effect on consumption from a change in house prices if this represents a change in their fundamental value. When the birth rate is positive, higher fundamental house prices driven by the housing demand of future generations will boost current consumption. There is a pure wealth effect on consumption from a change in house prices even in the representative agent model, if this reflects a change in the speculative bubble component of house prices. Two other channels through which a fall in house prices can affect aggregate consumption are (1) redistribution effects if the marginal propensity to spend out of wealth differs between those long housing (the old, say) and those short housing (the young, say) and (2) collateral or credit effects due to the collateralisability of housing wealth and the non-collateralisability of human wealth. A decline in house prices reduces the scope for mortgage equity withdrawal. For given sequences of future after-tax labour income and interest rates, a fall in house prices will then depress consumption in the short run while boosting it in the long run.

Highlights

  • The bold statement “Housing wealth isn’t wealth” was put to me over a decade ago by Mervyn King, Governor of the Bank of England, Chief Economist of the Bank of England

  • The OLG structure does not destroy the absence of wealth effects from a change in house prices, because the aggregate demand for housing services is not affected by a change in the distribution of wealth between the young and the old

  • In a closed economy representative agent model and in the Yaari-Blanchard OLG model used in the paper, there is no pure wealth effect on consumption from a change in house prices if this represents a change in their fundamental value

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Summary

Introduction

The bold statement “Housing wealth isn’t wealth” was put to me over a decade ago by Mervyn King, Governor of the Bank of England, Chief Economist of the Bank of England. Even if the impact effect or short-run effect on consumption of a change in house prices can be represented adequately through a higher marginal propensity to consume out of collateralisable housing wealth than out of non-collateralisable (human) wealth, in the long run, the lower net financial assets of the household will reduce consumption compared to what it would have been if the change in wealth had been due to a change in non-collateralisable wealth. Casey and Mulligan don’t take the ‘escape route’ stressed in the present paper, that there is a pure wealth effect from a change in house prices that reflects a speculative bubble instead. The determination of the equilibrium real wage, the real interest rate, the production of non-housing consumption goods and the relative price of housing services and other consumption goods is irrelevant from the point of view of establishing the two main propositions of the paper

The model
Findings
The pure wealth effect of house price changes on consumption
Conclusion
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