House prices bust was a major dimension of the recent Great Recession around the world. Nonetheless, contrary to all evidence, many political leaders have opted to dismiss the adverse impacts of shocks like negative equity (due to price declines and pre-crisis debt ramp ups) and wealth effects on aggregate demand (first order price effects).
An interesting study based on the U.S. data tests the aggregate impacts of house prices changes on consumption, while controlling for homeownership status (renters v owners).
Titled “House Prices, Local Demand, and Retail Prices
” and co-authored by Johannes Stroebel and Joseph Vavra (CESIFO WORKING PAPER NO. 5607, NOVEMBER 2015) the study used “detailed micro data to document a causal response of local retail price to changes in house prices, with elasticities of 15%-20% across housing booms and busts. Notably, these price responses are largest in zip codes with many homeowners, and non-existent in zip codes with mostly renters.”
In other words, not only impacts of house price changes are significant, they are also bifurcated across two types of home occupiers - owners and renters, with renters exhibiting effectively no sensitivity to home prices changes in terms of their demand.
The authors “provide evidence that these retail price responses are driven by changes in markups rather than by changes in local costs. … Markups rise with house prices, particularly in high homeownership locations, because greater housing wealth reduces homeowners’ demand elasticity, and firms raise markups in response. Consistent with this explanation, shopping data confirms that house price changes have opposite effects on the price sensitivity of homeowners and renters.”
Overall, “taken together, our empirical results provide evidence of an important link between changes in household wealth, shopping behavior and firm price-setting. Positive shocks to wealth cause households to become less price-sensitive and firms respond by raising markups and prices.”
So do house prices matter for aggregate demand? They do. Does homeownership smooth or amplify effects of shocks to house prices on the aggregate economy? It appears to amplify them. Should monetary and fiscal policies be asymmetric for areas with high homeownership concentration as opposed to areas with high renters concentration? Yep. Ditto for countries, instead of areas.
Of course, in the Euro area, how does one structure differential monetary policies across countries so diverse as renters-concentrated Germany vs homeowners concentrated Holland or Ireland? Err… can we check that one as yet another problem with Euro architecture?..