June 2010

Consumption Responses to Permanent and Transitory Shocks to House Appreciation

Juan Contreras and Joseph Nichols


We estimate the marginal propensity to consume (MPC) out of permanent and transitory shocks to house price appreciation. We consider two different models under which those shocks may affect consumption. In the first one, housing is a risky asset. In the second one, housing has a role as a consumption and as an investment good. In both, changes in the rate of house price appreciation may affect nonhousing consumption. Shocks to appreciation rates may happen when increases in future house prices are expected to differ from the current ones because heterogeneity, market failures or errors in expectations. We test the implications of those models empirically using the PSID's imputed total consumption from food consumption and self-reported house values, and base our identification strategy on two sources of variation in the appreciation rate. The first source depends on the fact that home prices are far more cyclical in areas where the supply of housing is relatively inelastic. The second source is households' perceptions about which parts of shocks to appreciation rates are permanent or transitory. We model households' self-reported rate of appreciation as an AR(1) process and use both the Hodrick-Prescott and the Kalman filter to separate households' perceptions about permanent and transitory shocks to appreciation. Our results show that (1) consumption responses to house wealth shocks vary greatly by area and depend upon the area-specific levels of temporal persistence and variance of those shocks; (2) the overall MPC out of those shocks is 3.5%; (3) the MPC out of permanent shocks is between 3.4% and 9.1%; and (4) the MPC out of transitory shocks is between 0.5% and 3.3%.

Full paper (Screen Reader Version)

Keywords: Life cycle, marginal propensity to consume, house prices

PDF: Full Paper

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

Back to Top
Last Update: September 18, 2020