Impending U.S. Spending Bust? The Role of Housing Wealth as Borrowing Collateral

Using data from the Panel Study of Income Dynamics, this paper considers the mechanism by which changing house values impact U.S. household spending. The results suggest that house values affect consumption by serving as collateral for households to borrow against to smooth their spending. The results show that the consumption of households who need to borrow against their home equity increases by roughly 11 cents per $1.00 increase in their housing wealth. Changing house values, however, have little effect on the expenditures of households who do not need to borrow to finance their consumption. Based on these results, the paper further finds that declining housing wealth has a relatively small implied negative impact on aggregate consumption expenditures. JEL Classifications: E21 Daniel Cooper is an economist in the research department at the Federal Reserve Bank of Boston. His e-mail address is [email protected]. This paper, which may be revised, is available on the web site of the Federal Reserve Bank of Boston at http://www.bos.frb.org/economic/wp/index.htm. A previous version of this paper was the first chapter (job market paper) of my doctoral thesis at the University of Michigan. I am particularly indebted to Matthew Shapiro for his guidance and support. I would also like to thank Ruediger Bachmann, Bob Barsky, Dennis Capozza, Adam Cole, Elizabeth Murry, Serena Ng, Michael Palumbo, Eric Sims, Frank Stafford, and Rebecca Thornton for helpful suggestions. The paper also benefited greatly from the comments of seminar participants at the University of Michigan and other locations. All errors are my own. The views expressed in this paper are those of the author and do not necessarily represent those of the Federal Reserve Bank of Boston or the Federal Reserve System. This version: November 13, 2009