Housing Wealth and Consumer Spending

• A wealth effect describes the phenomenon of individuals spending more as they become wealthier. This phenomenon occurs when the stock market goes up and the value of their stock portfolio increases or when the value of their home or other assets increases.
• Estimates have shown that the wealth effect is about 3 to 7 cents for each one dollar change in the equity value of the stock market. By contrast, academic researchers have shown that each extra dollar of housing wealth has a much larger impact. Furthermore, National Association of Realtors®-funded research by the Joint Center for Housing Studies at Harvard showed a much speedier consumer spending response from a change in housing wealth compared to a change in stock market wealth[1].
• But what about when the stock market or home values decline? In a 2008 paper, Case and Quigley[2] discuss reasons to suspect that the wealth effect of a decline in housing prices is much smaller than that of an increase and may ultimately be zero.
• But new evidence from the Federal Reserve’s Survey of Consumer Finances suggests that if people do what they say they will do, the opposite could be true.
• Based on responses to a question about behavior when asset values change, we learn that more people say that they will cut back on spending when asset values decline than agree that they will spend more when asset values increase.
• Because this is a new question[3] in 2009 (previously, respondents were only asked whether they would spend more if the value of assets went up), we can’t tell if people were more or less willing to spend less if the value of assets they owned declined, so we can’t know if the crisis and recession had an changed the way people responded. Further, people may not respond in practice the way they respond to a survey question.
• Researchers will continue to delve into this question as time passes and more evidence accumulates, but this small piece of the puzzle suggests that policies that shore up home values by stabilizing home prices can be very important for the economy.

Notes:

1. Full report available here.
2. Case, Karl E. and John M. Quigley 2008. How Housing Booms Unwind: Income Effects, Wealth Effects, and Feedbacks through Financial Markets. European Journal of Housing Policy, June 2008. Vol. 8, No2, 161-180.
3. When the things that I own increase (decrease) in value, I am more (less) likely to spend money.
   1. AGREE STRONGLY
   2. AGREE SOMEWHAT
   3. NEITHER AGREE NOR DISAGREE
   4. DISAGREE SOMEWHAT
   5. DISAGREE STRONGLY

Source: National Association of Realtors®

Toby’s Poll: