House Prices and Consumer Spending David Berger, Veronica Guerrieri, - PowerPoint PPT Presentation

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix House Prices and Consumer Spending David Berger, Veronica Guerrieri, Guido Lorenzoni, Joe Vavra BBLM, Departimento del Tesoro Giugno 2017

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Consumption Decline in Great Recession Total Consumption Non-Durable Goods Services 1.14 1.14 1.1 1.12 1.12 1.1 1973-75 1.1 1980 1.08 1.05 1982-83 1.08 1990-91 2001 1.06 2007-09 1.06 1.04 1.04 1.02 1 1.02 1 1 0.98 0.96 0.95 0.98 0 5 10 0 5 10 0 5 10 Quarter Since Recession Start

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Consumption Response to House Prices in the Data • deep consumption decline in Great Recession • growing literature points to large decline in housing wealth • various measures of consumption respond strongly to house price movements under various identifications: • Campbell and Cocco (2007): UK non-durable exp ( ≈ 1 . 22) • Case, Quigley and Shiller (2013): state-level data (0 . 03 − 0 . 18) • Mian, Rao, and Sufi (2013): county Mastercard spending + autos spending (0 . 13 − 0 . 26) • Stroebel and Vavra (2015): Nielsen homescan spending • puzzle relative to standard PIH model (Sinai and Souleles)

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Question broad question: can consumption models rationalize this evidence? in particular: • can a standard model with incomplete markets work? • what are the channels? • does the level/distribution of household debt matter? • can we rationalize the recent boom-bust episode?

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Results • wide class of Bewley-type of models ⇒ simple formula: ∆ C it = MPC it ( 1 − δ ) P t H it − 1 ∆ P t P t • holds exactly with strong assumptions, but typically a accurate approximation • estimate our formula in the data using BPP approach implies large elasticities consistent with: • calibrated model • other empirical estimates • general equilibrium exercise: boom-bust episode • main shock: expected housing appreciation shock • consumption response dominated by partial equilibrium • GE effect important for residential investment and for bust

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Set up • households indexed by i live J = 60 periods • work for J y = 35 periods and retired for J o = 25 • j it = age of household i at time t • two assets: a risk-free asset ( A it ) and housing ( H it ) • risk-free asset yields interest r • housing stock yields housing services one for one • depreciation rate δ and exogenous house prices P t

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Preferences • for household i at time t with j it < J : it H 1 − α U ( C it , H it ) = ( C α ) 1 − σ it 1 − σ • bequest motive for j it = J : � 1 − σ � Γ i +( 1 − δ ) P t + 1 H it +( 1 + r ) A it Ψ U ( C it , H it )+ β , 1 − σ P Xt + 1 Γ i = human wealth of offspring P Xt + 1 = price index that converts nominal into real wealth

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Constraints • budget constraint C it + P t H it + A it = Y it +( 1 − δ ) P t H it − 1 +( 1 + r ) A it − 1 • borrowing constraint − ( 1 + r ) A it ≤ ( 1 − θ )( 1 − δ ) P t + 1 H it • income process when agent works: Y it = exp { χ ( j it )+ z it } where χ ( j it ) age-dependent component and z it = ρ z it − 1 + η it • social security process as in Guvenen and Smith (2014)

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Benchmark • special case = permanent income: 1. no income uncertainty 2. no borrowing constraint 3. constant house prices • assume β ( 1 + r ) = 1 and Ψ = ( 1 − β ) − σ • perfect consumption smoothing: � � J ( 1 + r ) − j Y t + j +( 1 − δ ) PH t − 1 +( 1 + r ) A t − 1 ∑ C t = α ( 1 − β ) j = 0

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Benchmark: Some Numbers • elasticity of consumption to house prices dC C / dP ( 1 − δ ) PH t − 1 P = ∑ J j = 0 ( 1 + r ) − j Y t + j +( 1 − δ ) PH t − 1 +( 1 + r ) A t − 1 • set r = 2 . 5 % , then human wealth is ≈ Y / r = 40 Y • set ( 1 − δ ) PH = 2 . 15 Y and A = − 0 . 32 Y (2001 SCF) elasticity = 0 . 0514 • suppose household debt goes up by 0 . 5 Y so that A = − 0 . 82 Y elasticity = 0 . 0520

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Benchmark: Take Out • implication 1: aggregate elasticity is small relative to empirical literature • implication 2: aggregate elasticity minimally affected by household debt • implication 3: the old are the ones with higher elasticities

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix General Model: Simple Formula • Proposition : individual consumption response to a permanent change in house price: ∆ C it = MPC it ( 1 − δ ) P t H it − 1 ∆ P t / P t • 3 key assumptions: 1. liquid housing wealth 2. Cobb-Douglas/CRRA preferences • formula can be extended for CES and θ = 0 • results robust numerically for CES with θ > 0 3. house prices follow a random walk (special case: constant )

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Interpretation • important implication: larger consumption response the larger correlation of MPC and housing values • house price increases affect C in 4 ways: 1. endowment effect : existing house worth more ( C ↑ ) 2. income effect : housing more expensive ( C ↓ ) 3. substitution effect : housing relatively more exp. ( C ↑ ) 4. collateral effect : relaxed borrowing constraint ( C ↑ ) • our formula: consumption response represented as pure endowment effect! ⇒ effects 2-4 cancel out • however all effects are large in isolation (more later ...)

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Calibration • annual model → interest rate r = 2 . 4 % • intertemporal elasticity σ = 2 • housing depreciation rate δ = 2 . 2 % (BEA data) • collateral constraint θ = 0 . 25 (minimum down payment) • income process using PSID data: • life-cycle component to fit regression of earnings on age (as Kaplan and Violante 2010) • temporary component: ρ = 0 . 91, σ = 0 . 21 (as Floden and Linde 2001) • remaining parameters target life-cycle profiles of housing and liquid wealth in 2001 SCF data (9 age bins)

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Model Fit Housing wealth 3.5 3 2.5 2 1.5 1 25 30 35 40 45 50 55 60 65 70 Age Liquid wealth net of debt 2 Model SCF 2001 1 0 −1 25 30 35 40 45 50 55 60 65 70 Age

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Elasticities over the Life Cycle 0.55 0.5 0.45 0.4 0.35 30 35 40 45 50 55 Age

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Understanding the Life Cycle Housing over the lifecycle 3.5 3 2.5 2 1.5 1 25 30 35 40 45 50 55 Age MPC over the lifecycle 0.3 0.25 0.2 0.15 0.1 0.05 25 30 35 40 45 50 55 Age

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Decomposition 0.3 0.2 0.1 Substitution effect 0 Income effect Collateral effect Endowment effect -0.1 -0.2 30 35 40 45 50 55 Age

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix More on Decomposition • substitution, collateral, and "net-wealth" effect of similar size • "net-wealth" effect = endowment + income effect • borrowing constraints in our model ⇒ net-wealth effect > 0

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix More on Decomposition • substitution, collateral, and "net-wealth" effect of similar size • "net-wealth" effect = endowment + income effect • borrowing constraints in our model ⇒ net-wealth effect > 0 • Comparison to existing "small wealth effects" models: 1. PIH: • Collateral effect = 0 • Net-wealth effect ≃ 0 2. Sinai and Souleles (2005): • Collateral effect = 0 • Net-wealth effect = 0 • Substitution effect = 0

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Some Implications 1. all 4 effects are large in isolation consistent with DeFusco (2015): large collateral channel 2. larger consumption responses when both MPC and PH are large consistent with Mian, Rao, Sufi (2013): biggest effects for most levered

Motivation Baseline Model Full Model Empirics Boom-Bust Conclusions Appendix Baseline: Take Out • implication 1: aggregate elasticity over working life is large = 0.47 • implication 2: aggregate elasticity affected by household debt distribution • implication 3: the young are the ones with higher elasticities because are more levered (Attanasio et al. 2009)