Working Paper: CEPR ID: DP6920
Authors: Willem H. Buiter
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 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 fundamental value.There is a pure wealth effect on consumption from a change in house prices if this reflects a change in the speculative bubble component of house prices.Two other channels through which house prices can affect aggregate consumption are (1) redistribution effects if the marginal propensity to spend out of wealth differs between those long housing and those short housing 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, this may depress consumption in the short run while boosting it in the long run.
Keywords: house prices; speculative bubbles; wealth effect
JEL Codes: E2; E3; E5; E6; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Change in house prices (speculative bubble) (E32) | Wealth effect on consumption (E21) |
| Decline in house prices (R31) | Redistribution of wealth from homeowners to renters (R21) |
| Change in house prices (fundamental value) (G59) | No wealth effect on aggregate consumption (E21) |
| Marginal propensity to consume (homeowners vs. renters) (R21) | Redistribution effects (H23) |
| Decline in house prices (R31) | Limits mortgage equity withdrawal (G51) |
| Limits mortgage equity withdrawal (G51) | Depresses consumption in the short run (E21) |
| Decline in house prices (R31) | Future consumption increases (E21) |