Wealth Effect: Housing vs. Stocks18 April, 2012, 16:03. Posted by Zarathustra
Tags: Consumption function, Wealth effect
I touched on the issue of consumption in China, based on the Modigliani-type of consumption function in which people consume both out of disposable income and wealth. With the real estate prices falling in China, I have already raised some serious doubts on how consumption can possibly can be key driver of China’s growth (see here).
Here is also a reminder of an old study by Case, Quigley and Shiller (2006), in which they estimated that the wealth effect from housing wealth is possibly greater than the wealth effect from financial wealth (e.g. stocks):
The numerical results vary somewhat with different econometric specifications, and so any numerical conclusion must be tentative. We find at best weak evidence of a stock market wealth effect. However, we do find strong evidence that variations in housing market wealth have important effects upon consumption. This evidence arises consistently using panels of U.S. states and industrial countries and is robust to differences in model specification.
For example, according to the results presented in Table 2 for Model I, a ten percent increase in housing wealth increases consumption by roughly 1.1 percent for the international panel, while a ten percent increase in stock market wealth has virtually no effect upon consumption. For the panel of U.S. states in Table 2 (Model I), a ten percent increase in housing wealth and in stock market wealth have about the same effect on consumption – an increase of 0.4 percent. According to the ECM model, Table 4 (Model I), the immediate effect of a ten percent increase in housing wealth is an increase in consumption of one percent for the panel of Western countries, while a ten percent increase in financial wealth has a negligible effect. According to the same model, the immediate effect of a ten percent increase in housing wealth is an increase in consumption of 0.4 percent for the panel of U.S. states while a ten percent increase in financial wealth has no effect. (Actually, the point estimate is negative.) Absent a second shock, the effect of a ten percent increase in housing wealth is reduced to 0.3 percent after four quarters and to 0.2 percent after ten quarters.
These calculations should not imply a false precision in the interpretation of our econometric models. Nevertheless, they do support the conclusion that changes in housing prices should be considered to have a larger and more important impact than changes in stock market prices in influencing household consumption in the U.S. and in other developed countries.
This is, of course, not meant to be very precise. If this is applicable to Chinese case, however, that would explain that despite having a half-dead stock market, consumption growth has been relatively strong… for now anyway.