Housing Wealth, Credit Housing Wealth, Credit Conditions and Conditions and ConsumptionConsumption

Janine Aron, John MuellbauerJanine Aron, John Muellbauerand Anthony Murphyand Anthony Murphy

CSAE, Nuffield College and Hertford College, CSAE, Nuffield College and Hertford College, OxfordOxford

Bank of Spain/CEMFI Conference April 2007Bank of Spain/CEMFI Conference April 2007

Abstract Abstract

The role of housing wealth in explaining The role of housing wealth in explaining consumption is still controversial.consumption is still controversial.

Most empirical literature is marred by poor Most empirical literature is marred by poor controls for common drivers of both house prices controls for common drivers of both house prices and consumption: income, interest rates, credit and consumption: income, interest rates, credit supply conditions, other assets, income growth supply conditions, other assets, income growth expectations and changes in the unemployment expectations and changes in the unemployment rate.rate.

Abstract cont’dAbstract cont’d

When credit supply conditions ease, house price When credit supply conditions ease, house price booms usually follow. Omission of CCI biases booms usually follow. Omission of CCI biases housing wealth effect up. Breakdown in BOE housing wealth effect up. Breakdown in BOE model connected with missing credit channel.model connected with missing credit channel.

This paper studies data for the UK and SA with This paper studies data for the UK and SA with better controls. Credit markets liberalized in better controls. Credit markets liberalized in both and consumption to income ratios rose.both and consumption to income ratios rose.

Lack of asset price boom in 1983-2000 SA Lack of asset price boom in 1983-2000 SA illuminates the direct role of credit liberalization.illuminates the direct role of credit liberalization.

Literature ReviewLiterature Review Recent empirical studies of the housing-Recent empirical studies of the housing-

consumption link on macro data include:consumption link on macro data include:

Case et al (2005), Catte et al (2004), Iacoviello Case et al (2005), Catte et al (2004), Iacoviello (2004), Barrel and Davis (2004), Dvornak and (2004), Barrel and Davis (2004), Dvornak and Kohler (2003), Byrne and Davis (2003), Ludwig Kohler (2003), Byrne and Davis (2003), Ludwig and Sloek (2002) and Boone et al (2001). and Sloek (2002) and Boone et al (2001).

Earlier studies include Brodin and Nymoen Earlier studies include Brodin and Nymoen (1992), Kennedy and Andersen (1994) and (1992), Kennedy and Andersen (1994) and Muellbauer and Murphy (1995).Muellbauer and Murphy (1995).

Micro-dataMicro-data

Two studies on UK micro data with diametrically Two studies on UK micro data with diametrically opposed conclusions are Campbell and Cocco opposed conclusions are Campbell and Cocco (2005) and Attanasio et al (2005).(2005) and Attanasio et al (2005).

Attanasio et al (2005)Attanasio et al (2005) Micro data from the FES for 1978-2001 to Micro data from the FES for 1978-2001 to

explain consumption by age & cohort dummies, explain consumption by age & cohort dummies, household demography, housing tenure, household demography, housing tenure, regional house price growth rates & the level of regional house price growth rates & the level of house prices. house prices.

They find bigger house price growth rate effects They find bigger house price growth rate effects for the young, with the middle aged next and the for the young, with the middle aged next and the old last,& similar effects for home owners as for old last,& similar effects for home owners as for renters. renters.

Since housing wealth increases with age, claim Since housing wealth increases with age, claim house prices are just a proxy for omitted income house prices are just a proxy for omitted income expectations & have no direct effect.expectations & have no direct effect.

Critique of Attanasio et alCritique of Attanasio et al

Consumption is likely to be strongly affected by Consumption is likely to be strongly affected by current income, and also influenced by financial current income, and also influenced by financial asset ownership (also increasing with age and asset ownership (also increasing with age and differing by region), debt and variations in differing by region), debt and variations in unemployment rates, credit conditions and unemployment rates, credit conditions and interest rates.interest rates.

Their failure to include these controls implies Their failure to include these controls implies that no conclusions about the effects of housing that no conclusions about the effects of housing assets on consumption can be drawn. assets on consumption can be drawn.

Campbell and Cocco (2005)Campbell and Cocco (2005) Micro data from the FES from 1988-2000. Micro data from the FES from 1988-2000.

Explain changes in consumption per head for Explain changes in consumption per head for different cohorts classified by region, controlling different cohorts classified by region, controlling for income growth, regional unemployment, for income growth, regional unemployment, interest rates as well as housing tenure, interest rates as well as housing tenure, mortgage debt and regional house prices. mortgage debt and regional house prices.

Largest house price effects found for the older Largest house price effects found for the older homeowners and the lowest for renters. homeowners and the lowest for renters.

But latter is still significant: suggests in their But latter is still significant: suggests in their model house prices contain a general model house prices contain a general ‘confidence’ effect, as well as wealth effect.‘confidence’ effect, as well as wealth effect.

Some peculiar individual coefficients. Some peculiar individual coefficients.

Case, Quigley and Shiller (2005)Case, Quigley and Shiller (2005)

Claim that for, a panel of US states and a panel Claim that for, a panel of US states and a panel of 14 countries, the housing wealth effect is of 14 countries, the housing wealth effect is larger than the stock market wealth effect. larger than the stock market wealth effect.

However, their econometrics are questionable. However, their econometrics are questionable. Their so-called ECM, used on a panel of US Their so-called ECM, used on a panel of US states and 14 OECD countries takes the form:states and 14 OECD countries takes the form:

The Case et al (2005) ‘ECM’ The Case et al (2005) ‘ECM’

1 1

2 t 3 t

1 1 4 t-1

t

log log log

log stock log house

log log log stock

fixed effects +

t t t

t t

c α c β y

β β

γ c y β

ε

Case et al cont’dCase et al cont’d

where y is real income, stock is stock market where y is real income, stock is stock market wealth, house is owner-occupied housing wealth, house is owner-occupied housing wealth. 1986 step-dummy interacted with wealth. 1986 step-dummy interacted with log log house checks shifts.house checks shifts.

Among the omitted controls are levels of housing Among the omitted controls are levels of housing asset and stock market wealth, interest rates, asset and stock market wealth, interest rates, the unemployment rate, and income growth the unemployment rate, and income growth expectations effects.expectations effects.

Case et al cont’dCase et al cont’d

Pooling 14 countries denies heterogeneity due Pooling 14 countries denies heterogeneity due to institutional differences.to institutional differences.

Shifts in credit conditions are omitted from the Shifts in credit conditions are omitted from the OECD country data though Finland, Norway, OECD country data though Finland, Norway, Sweden, the UK and the Netherlands all went Sweden, the UK and the Netherlands all went through revolutions in credit availability.through revolutions in credit availability.

Not surprisingly, the supposed housing wealth Not surprisingly, the supposed housing wealth effect is even larger for the OECD countries, effect is even larger for the OECD countries, where credit conditions went through larger where credit conditions went through larger changes than for US states after 1982.changes than for US states after 1982.

Table 3: Case-Quigley-Shiller specification Table 3: Case-Quigley-Shiller specification of UK consumption function 1967-2005.of UK consumption function 1967-2005.

Dependent variableΔ log c

With non-property income

Regressors coefficient t- ratio coefficient t- ratio

Δ log c (-1)-4.2E-03 -0.073 -0.013 -0.23

Δ log y 0.23 5.0 0.23 5.0

Log y(-1) –log c(-1)0.013 0.73 0.013 0.75

Δ log house 0.10 3.6 0.090 3.1

Dum86* Δ log house0.027 0.72 0.029 0.77

Δ log stock 0.012 1.4 - -

Δ log stock-1 4.0E-03 0.47 - -

Δ log stockma8 - - 0.034 1.5

s.e 7.11E-03 7.10E-03

Adj. R2 0.611 0.613

D.W. 2.01 2.01

Implications for consumption of Implications for consumption of credit liberalizationcredit liberalization

Conventional view is that credit liberalization just Conventional view is that credit liberalization just makes inter-temporal consumption smoothing makes inter-temporal consumption smoothing easier.easier.

(Hence reduced ‘excess sensitivity’)(Hence reduced ‘excess sensitivity’)

Consumption con’tConsumption con’t

But credit market liberalization has 2 other But credit market liberalization has 2 other effects, both omitted in aggregate Euler equation effects, both omitted in aggregate Euler equation studies.studies.

Increased average cons/income (lower saving Increased average cons/income (lower saving rate) as those saving for durables, esp. housing, rate) as those saving for durables, esp. housing, save less because down-payments lower.save less because down-payments lower.

Consumption cont’dConsumption cont’d

Increased liquidity of ‘illiquid assets’ as e.g. Increased liquidity of ‘illiquid assets’ as e.g. housing collateral role enhanced.housing collateral role enhanced.

Thus missing level effects in standard Thus missing level effects in standard consumption functions, and missing time varying consumption functions, and missing time varying parameters because of interaction effects parameters because of interaction effects between CCI and housing wealth and other between CCI and housing wealth and other variables.variables.

Euler vs. solved out cons. fn.Euler vs. solved out cons. fn.

REPIH consumption function comes from REPIH consumption function comes from solving the Euler equations and life-cycle budget solving the Euler equations and life-cycle budget constraint.constraint.

Need income forecasting model to generate Need income forecasting model to generate permanent non-property incomepermanent non-property income

Solved out cons. fn. does not throw away long-Solved out cons. fn. does not throw away long-run info. on income, assetsrun info. on income, assets

Better for policy modelling, forecastingBetter for policy modelling, forecasting

Log-linearize REPIH cons. fn.Log-linearize REPIH cons. fn.Canonical REPIH consumption function:

Pttt yrAc 1 (1)

To log-linearize equation (1), note that

1)/)(//// 11 ttPtttt

Pttttt yyyyrAyyyrAyc (2)

Noting that xx )1log( -0.5x2, when x is small, and that tt yrA /1 is

small for most consumers, and that )/log(/)( tPttt

Pt yyyyy ,

)/log()/(5.0/loglog 211 t

Pttttttt yyyrAyrAyc (3)

M&L (1995) Handbook of A.E. M&L (1995) Handbook of A.E. consumption model where no consumption model where no

immediate credit constraintimmediate credit constraint

0 1 1 2

3

1 1

2 1 3 1

1

log

log /

/ /

log log

t t

t t k

t t t

t t t t

t t

r

E ym

c NLA y

IFA y HA y

y c

If some consumers credit If some consumers credit constrained, add…. constrained, add….

1 2 1log ( / ) logt t t t ty DB y nr

Transactions costs in housing Transactions costs in housing suggest possible capital gains termsuggest possible capital gains term

In principle, forward-looking capital gains term, In principle, forward-looking capital gains term, but backward looking if consumers crudely but backward looking if consumers crudely project past gains.project past gains.

)log)(/)(( 113 ttt rhpyHA

Micro-foundations of higher Micro-foundations of higher MPC out of liquid assetsMPC out of liquid assets

Otsuka (2006) sets up Carroll/Deaton-type Otsuka (2006) sets up Carroll/Deaton-type calibrated buffer stock saving model where calibrated buffer stock saving model where income process has downside.income process has downside.

Assumes credit limit.Assumes credit limit. Illiquid asset faces transactions cost, though Illiquid asset faces transactions cost, though

higher return.higher return. MPC higher for liquid assets than illiquid under MPC higher for liquid assets than illiquid under

optimal decision rule.optimal decision rule.

Forecast income growthForecast income growth

Δ log ymt+k is defined as a weighted moving average of

future income growth rates

= log permanent income minus log current income:

tsk

stsk

kt yyym log)/log(log 11

11

(3.5)

Call ym ‘yperm’.

Forecast income growth 2Forecast income growth 2

Income forecasting equation for Δlog yperm

where the discount factor is 0.85 and horizon

k is 3 years, Friedman (1963), Carroll (2001)

Truncate after 12 quarters.

Forecast income growth 3Forecast income growth 3

Naïve: regress Δlog yperm on a constant, trend, log y, and lags

in Δlog y. Evidence of trend reversion and mild short term

persistence in growth.

Sophisticated: use model selection, given long-run relationship

for log y as a function of trend (+), real interest rates (-), the logs

of real oil prices (-), share prices (+) and real house prices (+),

the rate of taxes on income (-), the rate of unionization (+)

(greater union power raises share of labour income), and some

national accounts ratios.

Forecast income growth 4Forecast income growth 4

Evidence for shift in fiscal policy around 1980: Evidence for shift in fiscal policy around 1980: less ‘Keynesian’ role of government budget less ‘Keynesian’ role of government budget surplus and less relevance of trade deficits.surplus and less relevance of trade deficits.

We also test for a shift in the early 1980s in the We also test for a shift in the early 1980s in the role of real house prices, to be consistent with role of real house prices, to be consistent with the shifting role of housing wealth in the shifting role of housing wealth in consumption with credit market liberalization consumption with credit market liberalization outlined in section 3(d) above. outlined in section 3(d) above.

We confirm the absence of a positive real house We confirm the absence of a positive real house price effect on income before the early 1980s.price effect on income before the early 1980s.

Results for canonical habits modelResults for canonical habits model

0 3 1 1

1 1 1 1 1

log

log /

/ / log log

t

t t k t t

t t t t t t

c

E ym NLA y

IFA y HA y y c

Striking support for buffer-stockidea

Regressors 1967:1-2005:4 MPC same

1967:1-2005:4MPC for net liquid

assets different

Coeff. t-rati0 Coeff. t-ratio

Speed of adjustment

α 0.17 4.6 0.26 6.2

Intercept α0 -0.019 1.3 -0.110 5.6

dlyperm α3 1.21 4.6 0.82 5.1

Net liquid assets/income

γ1 0.019 8.0 0.109 5.9

Illiquid assets/income

γ2 ditto ditto 0.030 10.5

s.e.   0.00799   0.00762  

adj. R sq. 0.509 0.554  

D.W. 1.38 1.34

Equation (4.1) in paper Equation (4.1) in paper

Includes crucial time variation of parameters with Includes crucial time variation of parameters with CCICCI

Includes -0.5xIncludes -0.5x2 2 asset/income term to improve asset/income term to improve log-linear approx.log-linear approx.

Uses ma4 of real interest rate and illiquid Uses ma4 of real interest rate and illiquid financial assets (Lettau and Ludvigson 2004 financial assets (Lettau and Ludvigson 2004 note gradual transmission of stock prices to note gradual transmission of stock prices to consumption)consumption)

CCI from BOE wp.314CCI from BOE wp.314

Fernandez-Corugedo and Muellbauer estimate Fernandez-Corugedo and Muellbauer estimate CCI as common factor in 10 jointly estimated CCI as common factor in 10 jointly estimated credit variables, after controlling for rich set of credit variables, after controlling for rich set of economic and demographic factorseconomic and demographic factors

Interpret as shift in credit supply functionInterpret as shift in credit supply function

Figure 1: UK personal consumption and Figure 1: UK personal consumption and disaggregated assets relative to personal disaggregated assets relative to personal

disposable non-property incomedisposable non-property income

0.025

0.050

0.075

0.100

0.125

0.150

0.175

0.00

0.25

0.50

0.75

1.00

1970 1975 1980 1985 1990 1995 2000 2005

log ratio ratio to income

log(c/y) (LH axis) illiquid financial assets/income

net liquid assets/income housing assets/income

Figure 2: Credit conditions index for the UK Figure 2: Credit conditions index for the UK and the real interest rateand the real interest rate

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

-0.10

-0.05

0.00

0.05

0.10

1970 1975 1980 1985 1990 1995 2000 2005

CCI %/100

CCI (LH axis) annual change in the unemployment rate

real interest rate (ma4)

UK empirical evidenceUK empirical evidence

CCI level effect is important: lowers hhold saving CCI level effect is important: lowers hhold saving rate by around 5% relative to pre 1980 (not rate by around 5% relative to pre 1980 (not G.E.).G.E.).

Interaction effects with CCI important:Interaction effects with CCI important:

-- Housing collateral effect on consumption rises Housing collateral effect on consumption rises with CCIwith CCI

-- Nominal rate effects weaken with CCINominal rate effects weaken with CCI-- Mild evidence that real rate effects strengthen Mild evidence that real rate effects strengthen

with CCIwith CCI

UK evidence cont’dUK evidence cont’d

-- Interaction effect with income growth Interaction effect with income growth expectationsexpectations

-- Interaction with uncertainty indicator is weakInteraction with uncertainty indicator is weak

-- MPC for liquid assets roughly 0.13; illiquid MPC for liquid assets roughly 0.13; illiquid financial wealth 0.02-0.03; housing wealth at financial wealth 0.02-0.03; housing wealth at CCI max also around 0.03.CCI max also around 0.03.

UK evidence cont’dUK evidence cont’d

Weaker long-run housing wealth effects than Weaker long-run housing wealth effects than often estimated. often estimated.

Omission of CCI biases results seriously: e.g. Omission of CCI biases results seriously: e.g. much slower speed of adjustment, weaker real much slower speed of adjustment, weaker real interest rate effects.interest rate effects.

Co-integration analysis suggests single vector Co-integration analysis suggests single vector linking log(c/y) and 3 asset/income ratios.linking log(c/y) and 3 asset/income ratios.

UK cons. fn. 1967-2005UK cons. fn. 1967-2005

1967:1-2005:4 no cci

1967:1-2005:4 with cci

Regressors

Coeff. t-ratio Coeff. t-ratio

Speed of adjustment α 0.27 7.3 0.34 8.7

Intercept α0 -0.11 3.5 -0.05 3.1

CCI CCI - - 0.26 4.7

Real rate α1 -0.018 0.3 -0.19 2.0

Uncertainty (Δ4ur), θ α2 -0.018 5.7 -0.018 7.3

logt t kE ym α3 0.45 4.4 0.19 1.8

logt t kE ym x CCI α3c - - 1.5 1.8

UK cons. fn. cont’d 1967-05UK cons. fn. cont’d 1967-05

Net liquid assets/income γ1 0.15 5.0 0.13 6.9

Illiquid financial assets/incomea γ2 0.033 5.9 0.024 7.4

Housing wealth γ3 0.041 4.8 - -

Housing wealth/income x CCI γ3c - - 0.13 8.9

Debt/income weighted change in log nominal interest rate

β2 -0.022 5.4 -0.052 4.2

Debt/income weighted change in log nominal interest rate x CCI

β2c - - 0.16 2.9

Diagnostics s.e 0.0063 0.0058

Adj. R2 0.696 0.742

DW 1.82 2.00

LM1 (p value) 0.73 0.27

LM4 (p value) 0.08 0.03

Sensitivity to income Sensitivity to income forecasting modelforecasting model

Use of average model consistent with Use of average model consistent with forecasting literature favouring averaging.forecasting literature favouring averaging.

We expected to find somewhat lower MPCs out We expected to find somewhat lower MPCs out of assets for sophisticated model than for naïve of assets for sophisticated model than for naïve model.model.

But found no significant difference.But found no significant difference. Can find income models implying slightly lower Can find income models implying slightly lower

MPCs out of assets.MPCs out of assets.

UK conclusionsUK conclusions Housing wealth effect largely works through the Housing wealth effect largely works through the

‘credit channel’: high collateral values give better ‘credit channel’: high collateral values give better access to credit and so raise consumption, Aoki access to credit and so raise consumption, Aoki et al (2002, 2004) et al (2002, 2004)

Important long-run effect of house prices on Important long-run effect of house prices on consumption contradicts BEQM - lacks consumption contradicts BEQM - lacks theoretical foundations for a credit channel. theoretical foundations for a credit channel.

Model explains recent shifts in correlation Model explains recent shifts in correlation between consumption and real house price between consumption and real house price changes: lower stock market values between changes: lower stock market values between 2001 and 2004, and the depressing effect of 2001 and 2004, and the depressing effect of higher debt to income ratio.higher debt to income ratio.

South AfricaSouth Africa Major data construction effort, see Review of Income Major data construction effort, see Review of Income

and Wealth 2006and Wealth 2006

We have no CCI (credit conditions index).We have no CCI (credit conditions index).

Hence estimate 2-equation system of debt and Hence estimate 2-equation system of debt and consumption.consumption.

Use dummies and prior knowledge of periods of credit Use dummies and prior knowledge of periods of credit liberalisation to estimate CCI from both equations.liberalisation to estimate CCI from both equations.

CCI indicator for South AfricaCCI indicator for South Africa

0.05

0.10

0.15

0.20

0.25

0.00

0.05

0.10

0.15

1970 1975 1980 1985 1990 1995 2000 2005

CCI real prime interest rate (ma4)

Comparing coefficients SA/UKComparing coefficients SA/UK Broadly consistent results – though we do not have Broadly consistent results – though we do not have

useful unemployment data for SA.useful unemployment data for SA.

Similar effects of liquid assets minus debt.Similar effects of liquid assets minus debt.

Results suggest somewhat higher IFA/y coeff. than Results suggest somewhat higher IFA/y coeff. than for UK – note pensions are separated out.for UK – note pensions are separated out.

Housing ‘wealth’ effect larger than for UK and shifts Housing ‘wealth’ effect larger than for UK and shifts less with CCI.less with CCI.

We suspect asset price effects not fully purged of We suspect asset price effects not fully purged of ‘confidence’, and some under-est. of wealth. ‘confidence’, and some under-est. of wealth.