How Large Is the Housing Wealth Effect? A New Approach

Christopher D. Carroll; Misuzu Otsuka; Jirka Slacalek

doi:10.3386/w12746

How Large Is the Housing Wealth Effect? A New Approach

Christopher D. Carroll, Misuzu Otsuka & Jirka Slacalek

Working Paper 12746

DOI 10.3386/w12746

Issue Date December 2006

This paper presents a simple new method for estimating the size of 'wealth effects' on aggregate consumption. The method exploits the well-documented sluggishness of consumption growth (often interpreted as 'habits' in the asset pricing literature) to distinguish between short-run and long-run wealth effects. In U.S. data, we estimate that the immediate (next-quarter) marginal propensity to consume from a $1 change in housing wealth is about 2 cents, with a final long-run effect around 9 cents. Consistent with several recent studies, we find a housing wealth effect that is substantially larger than the stock wealth effect. We believe that our approach is preferable to the currently popular cointegration- based estimation methods, because neither theory nor evidence justifies faith in the existence of a stable cointegrating vector.

This paper is based on material originally prepared for an Academic Consultants' meeting of the Board of Governors of the Federal Reserve System, January 30, 2004; for the version of the paper originally presented at the Fed, see Carroll (2004). We thank the discussant of that paper, Robert Shiller, as well as Ben Bernanke, Alan Greenspan, Robert Hall, Nicholas Souleles, Stephen Zeldes, the staff of the Fed, and other attendees at the meeting for very valuable feedback. The data and econometric programs that generated all of the results in this paper are available at http://www.econ.jhu.edu/people/ccarroll/. We are also grateful to Emmanuel de Veirman and Sherif Khalifa for excellent research assistance. For brief summaries of many of the papers in the literature at the time that paper was written, see Khalifa (2004). The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
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How Large Is the Housing Wealth Effect? A New Approach

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