Supersedes Working Paper 19-06 – How Big Is the Wealth Effect? Decomposing the Response of Consumption to House Prices

We quantify the role of heterogeneity in households' financial constraints in explaining the large decline in consumption between 2006 and 2009. Using household-level data, we show that in addition to a direct effect of changes in house prices, there are sizable indirect effects from general equilibrium feedback and bank health. About 60% of the aggregate response of consumption to changes in house prices is explained by ex-ante and ex-post financial constraints, where only a specific set of households face binding ex-post financial constraints as a result of declining house prices. We find a negligible wealth effect once we account for the role of heterogonous financial constraints.

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