Housing Price Wealth Effect?

This topic is rather stale, but it’s on my mind again, and it appears I never made this point before in this blog.

I have no doubt that home prices have a positive (as opposed to inverse) effect on consumer spending. But I quibble strongly (and who can quibble more strongly than I?) with the semantics when people refer to this effect as a wealth effect. Rising home prices do not, in general, increase aggregate wealth (or, as may be more relevant in the immediate future, falling home prices do not reduce aggregate wealth). For the relevant range of values, over the relevant time frame, in aggregate, households are short the housing market, not long the housing market.

If you own a house and plan to keep living in it, you gain no direct advantage when the market price rises. If you don’t own a house but hope to own one in the future, you do suffer a direct disadvantage when housing prices rise. Aside from builders and speculators, the only people who benefit directly from rising home prices are those who contemplate selling their homes either for the purpose of moving into a rental property or for the purpose of buying a less expensive home. Do you know a lot of people who fit into that category?

Granted, homeowners do gain an indirect advantage when home prices rise: the value of their collateral goes up, and they can borrow at a lower interest rate. (My former unsecured creditors and I are well aware of this effect.) This is partly a wealth effect, because it means that the present value of homeowners’ liabilities is reduced, thus increasing their net wealth. (With a little fancy economic theory, I could show that this is also a wealth effect for new borrowers, assuming they are behaving rationally.) But weigh this indirect benefit to current homeowners against the direct cost to future homeowners, and it would seem rather tough to come up with a positive net wealth effect. (I’m also ignoring the loss to creditors, who must accept lower interest rates, because I’m not prepared to deal with the thorny theoretical issue of risk adjustment.)

The positive effect of home prices on personal consumption has to do not with wealth but with liquidity constraints. Rising home prices increase consumption for the same reason that temporary tax cuts increase consumption: they put more money in people’s pockets (though mortgage equity withdrawal). Money, not wealth.