6/RT/13 Price expectations, distressed mortgage markets and the housing wealth effect

The life-cycle theory of consumption draws a well-established distinction between the implications for consumption of changes in wealth perceived to be of a “transitory” as opposed to a “permanent” nature. In this paper, using a unique combination of regulatory and survey micro-data, we examine the importance of the life-cycle theory, in estimating housing wealth effects for the Irish mortgage market. In the aftermath of the recent financial crisis, this market has experienced substantial levels of house price declines and negative equity. Thus, house price expectations are likely to be of major importance in influencing housing wealth effects. Our results suggest that mortgaged Irish households exhibit a relatively large wealth effect out of housing when compared with other countries and, in accordance with the life-cycle theory, households’ price expectations are influential in determining the consumption response to shocks. JEL classification: E21, R30, D12.