Many economists have stated that consumer spending can’t rebound until house prices stop falling. But Charles W. Calomiris of Columbia University, Stanley D. Longhofer of the Barton School of Business and William Miles of Wichita State University argue that the wealth effect of housing has been overstated.

Much commentary in the financial press over the last several months has been concerned with the impact of falling house prices on consumer spending. While some see evidence of “green shoots” and hope for economic growth over the horizon, many still fear that lower home values will depress consumer spending. This “wealth effect,” a drop in home values that causes consumers to cut back on purchases, is thought to dampen economic growth and hamper any recovery.

At first glance, it seems reasonable to expect such a wealth effect. If consumers are less wealthy because of declines in the value of the assets they own, whether they be stocks or their homes — it seems logical that they would cut back on their spending. Indeed, many prominent economists have conducted research purporting to find large housing wealth effects, and often argue that the wealth effect from homes exceeds that from equities. Moreover, the Federal Reserve employs a model, which presumably guides its policies, that assumes the housing wealth effect is large.

A more careful look at the data, guided by economic theory, however, suggests that much of this evidence has been misinterpreted and that the reaction of consumption to housing wealth changes is probably very small. First, several recent studies have shown that the logic of the housing wealth effect is faulty. Houses, unlike stocks, are not just assets but are also consumption goods themselves. Theoretical papers by Willem Buiter, as well as by Todd Sinai and Nicholas Souleles, cast doubt on the notion of a large spending effect from housing. Putting aside for the moment the question of how housing wealth may affect spending indirectly (via its effect on consumers’ access to credit), when considering the direct effect of housing wealth on consumption it is clear that any decrease in house prices hurts only those who are net “long” in housing, that is, those who own more housing than they plan to consume. This might include, for instance, “empty-nesters” who are planning on selling their current houses and downsizing. On the other hand, the decline in home values helps those who are not yet homeowners but plan to buy. Most homeowners, however, are neither net long nor net short to any significant degree; they own roughly what they intend to consume in housing services. For these households, there should be no net wealth effect from house price change. And when one thinks about the economy as a whole (which is a combination of all three types of households) the aggregate change in net housing wealth in response to house price change should be nearly zero; changes in house prices should affect the distribution of net housing wealth, but have little effect on aggregate net housing wealth. Thus any effect from net housing wealth change on aggregate consumption spending should be similarly small.

Put differently, an increase in house prices raises the value of the typical homeowner’s asset, but such a price increase is also an equivalent increase in the cost of providing oneself housing consumption. In the aggregate, changes in house prices will have offsetting effects on value gain and costs of housing services, and leave nothing left over to spend on non-housing consumption.

Up to this point, we have neglected the question of whether housing wealth change affects consumption through another, indirect channel — a financing channel — by affecting consumers’ access to credit. For example, if houses serve as better collateral than other wealth, then it is possible that “constrained consumers” (those who wish to borrow today and repay loans from anticipated increases in income in the future) may face better lending terms as the result of an increase in the value of their homes, which in turn may increase their non-housing consumption. Some observers point to the latest housing boom, and the increased use of HELOCS and other mortgages during the boom, as evidence that housing prices spurred consumption through this financing channel. While this indirect financing channel is a theoretical possibility, it is an empirical question whether it is significant in its effect, and even if the indirect financial effect is present it should not produce a “first-order” effect of housing wealth on consumption; housing wealth should still matter much less for consumption than other forms of wealth.

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