- House prices are the biggest form of consumer wealth in UK and US.
- A rise in wealth causes rising spending because:
- Increased wealth increases consumer confidence.
- Higher house prices enables you to remortgage against the value of your house and spend the equity released.
This simple analysis seems to be backed up by empirical evidence. Falling house prices seem to coincide with periods of economic downturn.
- In 1991, house prices fell 15%, pushing the economy into a deep recession (growth fell -2% in 1991)
- In 2008, house prices have fallen 10% and the UK again looks set to enter into recession. The US has had a delayed reaction, but, it is widely agreed falling house prices have contributed to lower consumer spending.
- Most people buy a house to live in. Whether house prices rise or fall makes no difference because the purpose of a house is not to provide equity gains and income.
- Some people may be affected by falling house prices. E.g. investors who are 'long' on housing. i.e. their ownership of houses is not just for living but gaining rentable income. However, Buiter argues that, these investors are offset by people who benefit from falling house prices. For example, first time buyers will be able to spend more on other items, if house prices are lower.
- Therefore, overall, changes in house prices do not affect consumer spending.
Who is Right - Do House Prices Really Have No Effect on the Economy?
In my case rising house prices didn't cause higher spending, and falling house prices hasen't reduced my spending. However, I still doubt Buiter's reasoning. This is why.
- In the consumer boom of 2001-2007, equity withdrawal played a significant role. For example, in quarter 4 of 2006, Mortgage equity withdrawal equalled £14.5bn or 7.3% of disposable income. (Bank of England MEW stats) This may seem only a small % of AD. But, since house prices have fallen and people are facing negative equity, this cause of consumer spending has dried up. It has provided an important catalyst for reducing consumer spending. See also previous post (equity withdrawal and economic growth)
- Most people own a House. 75% of houses are owner occupied. In other words when house prices fall, far more people lose out than gain. True, some first time buyers will be better off because of falling house prices, but, these are outnumbered by existing homeowners who see a fall in house prices.
- Some forms of wealth / assets have little impact because they are held by high income earners whose spending does not depend on share prices. Therefore, when share prices fall, most people don't reduce spending because most people don't own shares. But, falling house prices affects most income groups (especially since home ownership was extended in the 1980s)
- House Prices have become an important barometer of the state of the economy. House prices make front page news. Every monthly fall is reported with great vigour and excitement by the media. People have created a link between the housing market and the state of the economy. Falling house prices are generally seen to reflect the state of the economy. Therefore, falling house prices do contribute to a fall in consumer confidence and consumer spending.
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