Housing Activity and Consumer Spending: The Link Is Not as Strong as Often Supposed

Article excerpt

The current expansion has seen record-high levels of transactions in housing, extraordinary growth in the aggregate value of owner-occupied housing, and large increases in the amount of funds realized from the refinancing of mortgage debt. Many analysts thus have pointed to the strong housing market and rising home prices as a major pillar supporting recent economic growth and have expressed concern that a contraction in housing activity and values could pose a significant risk to consumer spending and real economic growth. This paper explores the channels by which the housing market may affect consumer spending and assesses the potential risk from a softening in the housing market. Our assessment is that while a housing slowdown by itself may slow consumer spending some, it is probably insufficient to precipitate a downturn without some additional shocks outside of the sector.

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The current expansion has seen record-high levels of transactions in housing, extraordinary growth in the aggregate value of owner-occupied housing, and large increases in the amount of funds realized from the refinancing of mortgage debt. At the same time, the macroeconomic data show that consumer spending has played a large role in recent economic growth. The simultaneity of these developments has suggested to many analysts that the strong housing market and rising home prices have been a major (if possibly unsustainable) pillar supporting the economy. Moreover, many of these analysts are concerned that a contraction in housing activity and values could pose a significant risk to consumer spending, accentuating the direct effect from a fall-off in residential construction. (1)

This paper explores the channels by which the housing market may affect consumer spending and assesses the potential risk to aggregate activity from a softening housing market. The channels we examine include the following:

* The direct mechanical relationship between housing and consumption; i.e., some components of consumer spending are complementary to housing transactions;

* The "wealth effect" from capital gains on housing;

* The influence of home equity extraction (which has increased greatly, stemming from less costly mortgage refinancing and more accessible home equity loans) on household spending behavior.

Our assessment is that a housing slowdown by itself may slow consumer spending and GDP growth some; however, it is probably insufficient to precipitate a downturn without some additional shocks outside of the sector. First, the amount of consumer spending more or less mechanically tied to housing transactions is fairly limited. Second, while the precise size of the wealth effect from gains in home prices is problematic, plausible estimates do not suggest that consumer spending growth would cease if there was a decline in home values on the order of recent gains. Third, it appears that much of the recent home equity withdrawal has been used to restructure household balance sheets as well as to finance consumer spending decisions based on fundamental consumption determinants (such as expected income growth) rather than on the availability of this source of funds.

The next portion of the paper reviews the basic facts on housing activity, aggregate home values, and the recent evolution of household wealth and spending. We then examine and assess the consumer spending impact of housing activity through the channels listed above. The last section provides concluding remarks.

Recent Trends in Housing, Household Wealth, and Spending

The two aspects of housing activity directly linked to real economic activity are construction and sales. Within the national income accounts, the data on home construction are contained in the residential investment component. This component consists of all outlays on home construction--renovations and improvements as well as new building of single and multifamily structures. …