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Consumption responses to permanent and transitory shocks to house appreciation

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  • Juan Contreras
  • Joseph Nichols

Abstract

We estimate the marginal propensity to consume (MPC) out of permanent and transitory shocks to house price appreciation. We consider two different models under which those shocks may affect consumption. In the first one, housing is a risky asset. In the second one, housing has a role as a consumption and as an investment good. In both, changes in the rate of house price appreciation may affect nonhousing consumption. Shocks to appreciation rates may happen when increases in future house prices are expected to differ from the current ones because heterogeneity, market failures or errors in expectations. We test the implications of those models empirically using the PSID's imputed total consumption from food consumption and self-reported house values, and base our identification strategy on two sources of variation in the appreciation rate. The first source depends on the fact that home prices are far more cyclical in areas where the supply of housing is relatively inelastic. The second source is households' perceptions about which parts of shocks to appreciation rates are permanent or transitory. We model households' self-reported rate of appreciation as an AR(1) process and use both the Hodrick-Prescott and the Kalman filter to separate households' perceptions about permanent and transitory shocks to appreciation. Our results show that (1) consumption responses to house wealth shocks vary greatly by area and depend upon the area-specific levels of temporal persistence and variance of those shocks; (2) the overall MPC out of those shocks is 3.5%; (3) the MPC out of permanent shocks is between 3.4% and 9.1%; and (4) the MPC out of transitory shocks is between 0.5% and 3.3%.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2010-32.

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Date of creation: 2010
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Handle: RePEc:fip:fedgfe:2010-32

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Keywords: Housing - Prices ; Real property ; Consumption (Economics);

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References

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Cited by:
  1. Calomiris, Charles W. & Longhofer, Stanley D. & Miles, William, 2013. "The Housing Wealth Effect: The Crucial Roles of Demographics, Wealth Distribution and Wealth Shares," Critical Finance Review, now publishers, vol. 2(1), pages 049-099, July.
  2. Arrondel, L. & Savignac, F. & Tracol, K., 2011. "Wealth Effects on Consumption Plans: French Households in the Crisis," Working papers 344, Banque de France.
  3. Irina A. Telyukova & Makoto Nakajima, 2011. "Reverse Mortgage Loans: A Quantitative Analysis," 2011 Meeting Papers 387, Society for Economic Dynamics.
  4. Dimitrios Christelis & Dimitris Georgarakos & Tullio Jappelli, 2011. "Wealth Shocks, Unemployment Shocks and Consumption in the Wake of the Great Recession," CSEF Working Papers 279, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 19 Oct 2011.

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