London House Prices

London House Prices

Abstract

Housing is a major component of wealth. Since house prices fluctuate considerably over time, it is important to understand how these fluctuations affect households' consumption decisions. Rising house prices may stimulate consumption by increasing households' perceived wealth, or by relaxing borrowing constraints. This paper investigates the response of household consumption to house prices using UK micro data. Weffestimate the largest effect of house prices on consumption for older homeowners, and the smallest effect, insignificantly different from zero, for younger renters. This finding is consistent with heterogeneity in the wealth effect across these groups. In addition, we find that regional house prices affect regional consumption growth. Predictable changes in house prices are correlated with predictable changes in consumption, particularly for households that are more likely to be borrowing con-strained, but this effect is driven by national rather than regional house prices and is important for renters as well as homeowners, suggesting that UK house prices are correlated with aggregate financial market conditions.

TABLE OF CONTENT

CHAPTER 1: INTRODUCTION5

Overview5

Study Objective7

CHAPTER 2: LITERATURE REVIEW10

Classifying the Drivers of Arrears and Possessions11

Trigger Events13

Unemployment13

Change in Income15

Illness17

Financial Resources17

Savings18

MPPI18

Financial Commitments19

Interest Rates and Housing Characteristics19

Other Factors21

Equity Drivers of Arrears and Possessions22

Liquidity of Housing Assets26

CHAPTER 3: RESEARCH METHODOLOGY28

Research method28

Data Collection28

Family Expenditure Survey28

Life-cycle patterns30

Regional and homeownership cohorts31

House price data31

Data Analysis32

CHAPTER 4: RESULT AND DISCUSSION34

House Price Changes and Consumption34

Baseline regression34

Results for regional cohorts34

Results for homeownership cohorts37

Selection Bias and a Simulated Housing Model38

Predictable changes in house prices40

CHAPTER 5: CONCLUSION42

REFERENCES44

APPENDIX51

CHAPTER 1: INTRODUCTION

Overview

Housing is the dominant component of wealth for the typical household in the United States or the United Kingdom. Bertaut and Starr-McCluer (2002) show that residential property accounted for about one quarter of aggregate household wealth in the US in the late 1990's, while Banks and Tanner (2002) report that real estate accounted for 35% of aggregate household wealth in the UK in the mid 1990's. Housing wealth is particularly important for middle-class households: Tracy and Schneider (2001), for example, show that it accounts for almost two-thirds of the wealth of the median US household. The share of housing is likely to be even higher today after several years of strong house price growth.

Houses are risky assets with volatile prices. Much of this volatility is local, but there is a common component to house prices that is visible in regional and even national house price indexes. National house price volatility is particularly striking in the UK, a geographically compact country with a nationally integrated housing market. Figure 1 shows the evolution of house prices in the United Kingdom between 1988 and 2000, a period in which annual changes in nominal house prices ranged from -10% to 30%.

The magnitude and volatility of housing wealth have led many to suggest that house price changes have significant effects on aggregate consumption. Muellbauer and Murphy (1990), for example, argued that house price increases and financial liberalization stimulated a consumption boom in the UK in the late 1980's. More recently Case, Quigley, and Shiller (2003) find a strong correlation between aggregate house ...