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How Large Is the Housing Wealth Effect? A New Approach

  • Christopher D. Carroll
  • Misuzu Otsuka
  • Jirka Slacalek

This paper presents a simple new method for estimating the size of ‘wealth effects?on aggregate consumption. The method exploits the well-documented sluggishness of consumption growth (often interpreted as ‘habits?in the asset pricing literature) to distinguish between short-run and long-run wealth effects. In U.S. data, we estimate that the immediate (next-quarter) marginal propensity to consume from a $1 change in housing wealth is about 2 cents, with a final longrun effect around 9 cents. Consistent with most recent studies, we find a housing wealth effect that is substantially larger than the stock wealth effect. We believe that our approach has sounder theoretical foundations than the currently popular cointegration-based estimation methods, because neither theory nor evidence provides any reason for faith in the existence of a stable cointegrating vector.

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Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 535.

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Date of creation: Oct 2006
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Handle: RePEc:jhu:papers:535
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