How Big is the Wealth Effect? Decomposing the Response of Consumption to House Prices

35 Pages Posted: 24 Jan 2019 Last revised: 21 Feb 2019

See all articles by S. Boragan Aruoba

S. Boragan Aruoba

University of Maryland

Ronel Elul

Federal Reserve Bank of Philadelphia

Sebnem Kalemli-Ozcan

University of Maryland - Department of Economics; National Bureau of Economic Research (NBER); Koc University, Graduate School of Business

Date Written: 2019-01-22

Abstract

We investigate the effect of declining house prices on household consumption behavior during 2006-2009. We use an individual-level dataset that has detailed information on borrower characteristics, mortgages and credit risk. Proxying consumption by individual-level auto loan originations, we decompose the effect of declining house prices on consumption into three main channels: wealth effect, household financial constraints, and bank health. We find a negligible wealth effect. Tightening householdlevel financial constraints can explain 40-45 percent of the response of consumption to declining house prices. Deteriorating bank health leads to reduced credit supply both to households and firms. Our dataset allows us to estimate the effect of this on households as 20-25 percent of the consumption response. The remaining 35 percent is a general equilibrium effect that works via a decline in employment as a result of either lower credit supply to firms or the feedback from lower consumer demand. Our estimate of a negligible wealth effect is robust to accounting for the endogeneity of house prices and unemployment. The contribution of tightening household financial constraints goes down to 35 percent, whereas declining bank credit supply to households captures about half of the overall consumption response, once we account for endogeneity.

Keywords: Financial crisis, mortgage, individual-level data, general equilibrium, bank health, credit supply

JEL Classification: E32, O16

Suggested Citation

Aruoba, S. Boragan and Elul, Ronel and Kalemli-Ozcan, Sebnem, How Big is the Wealth Effect? Decomposing the Response of Consumption to House Prices (2019-01-22). FRB of Philadelphia Working Paper No. 19-6. Available at SSRN: https://ssrn.com/abstract=3321609 or http://dx.doi.org/10.21799/frbp.wp.2019.06

S. Boragan Aruoba (Contact Author)

University of Maryland

College Park
College Park, MD 20742
United States

Ronel Elul

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States
215-574-3965 (Phone)

Sebnem Kalemli-Ozcan

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Koc University, Graduate School of Business ( email )

Rumelifeneri Yolu
34450 Sar?yer
Istanbul, 34450
Turkey

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