Question

ECON 212 Spring 2017

HW 1 (Chapter 1)

Case 1:

Do changes in housing wealth affect consumption spending ?

From 2000 to 2006, housing prices increased sharply in many parts of the United States. The figure on the next page shows the S&P/Case-Shiller index of housing prices, which represents changes in the prices of single-family homes. As measured by this index, housing prices increased nearly 90 percent between the beginning of 2000 and the beginning of 2006. Housing prices then declined more than 30 percent between the beginning of 2006 and the beginning of 2009. Housing wealth equals the market value of houses minus the value of loans people have taken out to pay for the houses. For example, someone who owns a house with a market price of $200,000 and who has a mortgage of $150,000 would have housing wealth of $50,000. Between 2000 and 2005, total housing wealth increased by about $5.5 trillion before falling by $7.0 trillion through mid-2011.

Source: S&P/Case-Shiller, standardandpoors.com.

Did these big swings in housing wealth affect consumption spending? Economists are divided in their opinions. Charles Calomiris of Columbia University, Stanley Longhofer of the Barton School of Business, and William Miles of Wichita State University argue that changes in housing wealth have little or no effect on consumption. They argue that consumers do not consider houses to be assets similar to their holdings of stocks and bonds because they own houses primarily so they can consume the housing services a home provides. Only consumers who intend to sell their current house and buy a smaller one—for example, “empty nesters” whose children have left home—will benefit from an increase in housing prices. But taking the population as a whole, the number of empty nesters may be smaller than the number of first-time home buyers plus the number of homeowners who want to buy larger houses. These two groups are hurt by rising home prices. Although it appears that consumption increases when housing prices increase, in fact, increases in income are responsible for both the increases in housing prices and the increases in consumption; increases in housing prices have no independent effect on consumption. (This is an example of the omitted variable problem discussed in the appendix to Chapter 1.) Atif Mian and Amir Sufi, both of the University of Chicago, strongly disagree with Calomiris, Longhofer, and Miles. Mian and Sufi tracked a sample of 70,000 consumers from 1998 to 2008 and found that consumers living in cities that experienced dramatic increases in housing prices borrowed heavily as their housing wealth increased. Consumers used these borrowed funds to increase their spending on goods and services.

Mian and Sufi believe that the sharp decline in consumption spending in 2008—the largest since 1980—occurred because falling housing prices resulted in lower housing wealth and lower consumer borrowing to finance spending. The debate over the effect of changes in housing wealth on consumption spending illustrates an important fact about macroeconomics: Many macroeconomic variables, such as GDP, housing prices, consumption spending, and investment spending, rise and fall at about the same time during the business cycle. Because many macroeconomic variables move together, economists sometimes have difficulty determining whether movements in one variable are causing movements in another variable.

Sources: Atif R. Mian and Amir Sufi, “House Prices, Home Equity–Based Borrowing, and the U.S. Household Leverage Crisis,” American Economic Review, Vol. 101, No. 5, August 2011, pp. 2132–2156; Atif Mian and Amir Sufi, “Housing Bubble Fueled Consumer Spending,” Wall Street Journal, June 25, 2009; Charles W. Calomiris, Stanley D. Longhofer, and William Miles, “The (Mythical?) Housing Wealth Effect,” National Bureau of Economic Research Working Paper 15075, June 2009; and Charles W. Calomiris, Stanley D. Longhofer, and William Miles, “The (Mythical?) Housing Wealth Effect,” Wall Street Journal, June 22, 2009.

Question: Writing about the state of the British economy, an article in the Economist argued that weak stock markets and diminishing housing wealth will affect spending. Would Calomiris, Longhofer, and Miles agree with this argument? Would Mian and Sufi? Briefly explain.

Answer 1

Colomiris, longhofer and miles will agree that weak stock markets will affect spending but they will not agree that diminishing housing wealth will affect spending. According to them while some will loose (who are selling homes) others who want to purchase house first time or bigger houses will gain by price fall. According to them it is infact decrease in income which leds to fall in spending

Mian and sufi will agree with this statement. According to them falling prices of houses would led to lowering borrowing for consumption. Also lower prices of stocks would result in lower spending.