1. Introduction
Evaluating the dynamics of the wealth effect on the U.S. economy has been growing in importance in the wake of the recent housing bubble. The literature reveals that income and wealth are the essential drivers of consumption, and fluctuations in the value of the wealth components, such as housing and financial wealth, result in some cyclical fluctuations in household consumption. Although there are some mixed results with respect to the selected sample, time period, and model specification, to name a few, there has been a growing consensus that the housing wealth effect is generally greater than the financial wealth effect in the U.S. (i.e., see, [
1,
2,
3,
4,
5,
6]). However, variations in financial wealth effect are also important for the countries that are characterized by a market-based financial system and a larger stock ownership such as in the case of the U.S. The wealth effect literature is already extensive. Most of the existing evidence on the wealth effect studies is based on a limited data set involving aggregate and micro (survey) data. This paper uses an expanded dataset with regional data to reinvestigate the classic research problem of wealth effect, or the link between wealth and consumption [
7] in the U.S. In this respect, except for [
8], no comprehensive systemic analysis has been conducted using data for the U.S. economy at the state-level. There are state-level wealth effect studies for the U.S. (i.e., [
5,
6,
8,
9]), but, to the best of our knowledge, our study is the first empirical attempt to analyze multi-horizon wealth effects across U.S. states over the period of 1975:Q2 to 2012:Q2 by utilizing multi-period non-causality testing [
10] and causality measurement [
11]. An analysis of the causality linkages between wealth and consumption across different prediction horizons and states provides a micro-level fresh perspective to the empirical literature.
This article contributes to the wealth effect literature in four aspects. First, we use a unique data set that allows us to document the presence of income, housing, and financial wealth effects across U.S. states. In addition to the aggregate-level evidence, our study provides state-level evidence to the role of housing and financial wealth effects in consumption by improving further on [
5,
8]. Second, our study is the first to classify U.S. states with respect to the relative importance of housing/financial wealth effects. This attempt may provide an interesting knowledge for federal and state-level policymakers in the U.S. Third, we apply a new methodological approach that enables us to compare the intensity of wealth effects at various time horizons in terms of predictability. This methodological improvement provides comparative evidence sensitive to the different model specifications. Fourth, based on our unique data set and application, we refine the scope of the wealth effect by comparatively analyzing aggregate and state-level income, housing, and financial wealth effects. Our main questions are addressed below.
The goal of this paper is to better understand the wealth effect-induced household consumption behaviors in the U.S. states, in particular: (i) whether state-level wealth effect dynamics in the U.S. differ from aggregate level dynamics, (ii) whether wealth effect upon consumption occurs at different time horizons at the state level, (iii) which wealth effect component is more intense in the short-run and long-run, (iv) whether the results are robust to different model specifications, and (v) whether the U.S. states can be classified with respect to which wealth effect is more dominant (housing or financial) based on some criteria such as short-/long-term persistency and magnitude of coefficient value of a wealth effect component. Eventually, by investigating these empirical questions, our study sheds more light on the field-classical research topic on which wealth effects matters the most for the household consumption in the U.S.
Causality measurement reveals that housing wealth constitutes the most crucial determinant of consumption growth changes from an economic viewpoint. Our evidence suggests that changes in housing wealth generate more intense, persistent, and widespread impacts on consumption growth at the aggregate and state level when compared with financial wealth. Moreover, although we document the presence of both financial and housing wealth effects upon consumption at long horizons, the results show that there is heterogeneity in the wealth effect patterns across U.S. states.
The remainder of the paper is organized as follows. The next section documents the literature review.
Section 3 provides a discussion of our methodology. Data and empirical results are presented and discussed in
Section 4. Finally,
Section 5 concludes the paper.
2. Literature Review
The life cycle-permanent income [
12,
13,
14] hypothesis is widely accepted as the proper application of the theory of the consumer to the problem of dividing consumption between present and future. According to the hypothesis, consumers form estimates of their ability to consume in the long run and then set current consumption to the appropriate fraction of the estimate. The estimate may be stated in the form of wealth, following [
12], in which case the fraction is the annuity value of wealth, or as permanent income, following [
14], in which case the fraction should be very close to zero [
15]. Due to data constraints for pension and social security wealth, housing wealth studies have generally used financial and housing wealth data in their analyses [
16].
Although the empirical literature presents some mixed evidence, common patterns of wealth effects are documented in different samples. First, in general, housing and financial wealth play a significant role in income, saving, consumption behaviors and in economic growth. Second, the business cycle of the economy is a determinative factor of the magnitude of the wealth effect. Namely, a rising (declining) stock/housing market may increase (decrease) wealth effect components to different degrees as observed before/after global financial crisis periods. There may also be parallel relations between real estate and business cycles for those countries/regions where real estate and the general economy have strong linkages. Ref. [
17] argues that the real estate cycle amplified the business cycle significantly in the late 1980’s in New England. The global financial crisis was the latest example of this relation for at least the U.S., UK, and Ireland. Ref. [
18] indicate that increasing optimism in consumers is likely to increase consumption of housing and non-housing goods. Ref. [
19] show that while the real house price generally leads real GDP per capita, both during expansions and recessions, significant feedback effect from the real GDP per capita onto the real house price also exists. These findings also occur during the recent financial crisis and Great Recession. Third, depending on the phase of the business cycle and the market, housing and financial wealth effects have some cyclical and non-asymmetrical features as well (i.e., [
8,
20,
21,
22,
23]). Fourth, the importance of housing and financial wealth is determined by various factors such as the level of mortgage market completeness and financial development, the ownership level/structure in housing/stock markets, and market-specific policies (i.e., protection of rights, transaction cost, information asymmetry etc.). Although it is generally difficult to make a generalization among countries from a housing/wealth effect perspective, it seems that while financial wealth may become a primary wealth effect source in Anglo-Saxon and/or market-based economies, housing wealth effect may become a primary source in bank-based and some developing countries (i.e., [
24,
25,
26,
27]).
The variations in household consumption sensitivity to wealth effects depends on various factors such as liquidity conditions [
28], utilities derived from the property right and the role of bequest [
29], distributions of wealth among income groups, expected permanency of changes, measurement biases of wealth [
30,
31], housing/stock market features of the analyzed country/province, the policies, and behaviors and demographics of asset owners. However, ref. [
32] discusses that standard measures of wealth may not adequately reflect newly emerging economic concerns such as sustainability.
Differences of marginal propensity to consume in housing/stock markets are generally explained by the well-documented differences in nature and risk characteristics of housing/stock as the asset classes (see, [
25,
33]). For example, ref. [
34] provide evidence that imperfect knowledge of households with respect to their financial wealth may result in them reacting instantaneously to changes in wealth. Ref. [
35] discuss that the psychology of framing may dictate that certain assets are more appropriate to use for current expenditures, while others are earmarked for long-term savings. Ref. [
8] note that the emotional impact of accumulating stock market wealth may be quite different from that of real estate wealth. People are likely to be less aware of the short-run changes in real estate wealth since they do not receive regular updates on its value. Stock market wealth can be tracked daily online. Ref. [
36] argue that housing and stock markets respond rather differently to negative shocks when the stock market is more volatile, but price rigidity is found in the housing market. From the micro-analysis perspective, the magnitude of the wealth effect is also related to demographic features. From the housing market perspective, ref. [
37] discuss that house price appreciation increases the net worth and consumption of all homeowners, while it only improves the welfare of older homeowners. Ref. [
8] underline that the importance of housing market wealth and financial wealth in affecting consumption is an empirical matter. For example, in an earlier study, using aggregate data in explaining U.S. consumer expenditures over the period of 1960 to 1977, ref. [
38] finds that fluctuations in the net value of household holdings of consumer durables and real estate do not associate significantly in consumer spending and values of expenditure elasticity of stock price change with mean values in the 0.030–0.055 range. Empirical work, such as [
20,
39], suggests at best a weak link between house price changes and nonhousing consumption. Refs. [
40,
41] find similar housing/stock wealth elasticities in their estimations. Ref. [
29] discusses that house price fluctuations possibly trigger smaller consumption changes than do stock market fluctuations. The extent to which an unanticipated increase in house prices raises a household’s real wealth depends on the time horizon over which the household plans to live in their current home. It is noted from the U.S. Survey of Consumer Finances, in 1998 and 2001, that more than two-thirds of households are homeowners, while only half owned stock, bonds, and mutual funds concentrated in pension/retirement accounts, ref. [
1] argue that the level of marginal propensity to consume in real estate or financial wealth is a determinative factor in economic stabilization.
The recent empirical literature provides a large body of evidence on the larger and persistent source of housing wealth in general and for the U.S., in particular. For example, ref. [
42] indicate that change in household net worth caused by a change in house prices is larger than the change from similar variation in stock values for the vast majority of households. By estimating the consumption function for the U.S. economy with real estate and financial wealth for quarterly data for 1952:Q1–2001:Q4, ref. [
1] find that an additional dollar of real estate wealth increases consumption by 8 cents, as compared with only 2 cents for financial wealth. Ref. [
2] finds that the effect of housing wealth is somewhat smaller than that of financial wealth for most of the investigated countries, but not for the U.S. and the UK [
43], consistent with several recent studies, find a housing wealth effect that is substantially larger than the stock wealth effect for the U.S. Ref. [
3] find that overall wealth effect from housing is stronger than the effect from financial wealth for all countries involving the U.S. Housing wealth effect is consistently stronger for the oldest group in Canada and the late middle-aged groups in Finland and Italy. Authors suggest that policymakers should keep an eye on housing market developments separately from financial markets. Ref. [
4] research findings indicate relatively large housing wealth effects for the U.S. Among homeowners, the housing wealth elasticities are estimated in the range of 0.06 over the 1989–2001 period. Ref. [
43] suggest that it is not certain that the housing wealth effect is substantially larger than the financial wealth effect for the U.S., but monetary policies should follow housing markets separately from equity markets due to its significantly higher MPC from housing wealth. Ref. [
9] find a strong association between consumption and housing wealth declines in the period after the real estate bubble burst in the U.S. Ref. [
44] document that the housing wealth effect is more intense than the stock wealth effect for a panel of countries involving the U.S. over the period from 1970:Q1 to 2015:Q4. They argue that housing is a powerful asset transmission channel irrespective of the size, financial structure, and geographic location of the analyzed economies. By employing a multistep non-causality test [
10] and causality measures [
11,
45] investigate the nature of the intertemporal relationship between household wealth and private consumption across the G7 countries. The authors document the absence of short-horizon causality and the presence of long-horizon causality across variables.
Analyses of the role of housing wealth in the determination of consumption spending have used one of three types of information: aggregate time-series data at the state or national level, micro-data from household-level surveys, and data based on refinance activity [
4]. It seems that studies are mostly focused on aggregate and micro-level data [
46]. From a regional data perspective, by following [
31] and using a state-level panel for the Australian economy, ref. [
30] find larger effects for financial wealth, but smaller effects for housing wealth. Using threshold regression to explore the asymmetric effects of housing price on consumption, ref. [
47] investigate the linkage for 35 major Chinese cities. The authors argue that the housing market is indeed equally or even more important to the transmission channels from housing wealth to consumption in China. Based on China Family Panel Studies, ref. [
48] find that urban housing price influences some nonessential expenditure items like education, medical, and transportation.
In parallel to studies for other countries, wealth effect studies based on state-level data (and region, city) are also scarce for the U.S. Using aggregate data, ref. [
17] finds evidence of a significant consumption effect during the real estate price boom in the late 1980’s for New England. Ref. [
8] estimate stock market wealth, housing market wealth and consumption for each U.S. state, quarterly, for the period 1982–1999. They find at best weak evidence of a stock market wealth effect and strong housing wealth effect. Ref. [
5] use similar data sources to [
8] while they estimate regression models in levels, first differences and in error-correction form over the period of 1975 through 2012:Q2 for U.S. states. They document a statistically significant and rather large effect of housing wealth upon household consumption. Among others, they argue that a decline of 35% in housing wealth would lower consumer spending by 3.5% in the U.S. The authors further indicate that changes in housing wealth and stock market wealth do not move closely with per capita income across states. The most dramatic cyclical pattern is in California and the patterns in Florida and Arizona are much like that in Texas. Ref. [
33] examine the nature and causal direction of the relationship between house prices and economic growth proxied by per capita personal income for a panel of 351 U.S. metropolitan statistical areas. The authors find a long-run relationship between local house prices and per capita personal income and also the existence of a bi-directional causality between real house prices and real per capita personal income over both long and short-horizons. Ref. [
49] investigate the presence of causal linkages between asset prices and output per capita across the 50 U.S. states and DC over the period 1975–2012:Q2 by implementing a bootstrap panel causality framework. Their findings indicate when controlling for cross-state dependency, heterogeneity and asset market interconnections, causality runs from asset prices (both housing and stock prices) to output, not only at the level of individual states, but also taking together all the agricultural and industrial states. Using geographically linked microdata, ref. [
50] finds that a USD 1 increase in home values in the U.S. leads to a USD 0.047 increase in spending for homeowners, but a negligible response for renters. By analysing the 1978–2017 period for the city-level data of the U.S., time-varying estimates of [
51] indicate that housing wealth effects were not particularly large in the 2000s. Ref. [
6] provide evidence that the elasticities of consumption with respect to financial wealth and housing wealth vary considerably across U.S. states, with housing wealth effects being larger than financial wealth effects in 37 cases.
Overall, not surprisingly, housing and financial wealth effects may exhibit heterogeneity across regions involving U.S. states/cities if we account for the differences in ownership level in financial/housing assets, demographics, income-wealth level/distribution, consumption behaviours shaped by socio-econonomic/cultural structures, access to finance and credit constraints, etc.
5. Conclusions
The housing and financial wealth effects on consumption have been widely analyzed for the U.S. economy due to housing and stock market-centered policies since the mid-1990s. Stock and housing market boom-bust episodes during almost the entire 2000’s have also highlighted the importance of a better understanding of the foundations of wealth effects. While the magnitude and drivers of wealth effects have been broadly analyzed for the U.S. economy at the aggregate level, questions remain about the intertemporal co-behavioral patterns between housing/financial wealth and consumption growth at the state level. This paper provides new evidence that sheds more light on the dynamics of housing and financial wealth effects in the U.S. states.
The major findings of our investigation can be summarized as follows. First, based on the multi-horizon non-causality test of [
10], our empirical results suggest that (i) housing (financial) wealth growth Granger cause consumption growth in 37 (43) States implying that both effects are simultaneously important at the state level, (ii) at the aggregate level, although financial wealth induces stronger short-/long-run effects upon consumption, changes in housing wealth trigger more persistent effects both in the short and long run, (iii) housing and financial wealth effects occur at both short and long time horizons in the majority of states, and (iv) we find in Minnesota and Pennsylvania the strongest and most persistent housing/financial wealth effects upon consumption. Second, the application of the multi-horizon causality measure of [
11] at the state level indicates that the causality measure from housing (financial) wealth growth to consumption growth is statistically significant at different forecast periods in 31 (9) states. Ref. [
11] test results also suggest that (i) while financial wealth has no statistically significant effect, housing wealth has statistically significant effects upon consumption at all time horizons at the aggregate level; (ii) housing is the dominant and the most persistent wealth effect component at the state level across different time horizons; and (iii) while housing wealth effects occur at both short and long time horizons across many states, financial wealth effects are found only at short-time horizons. Third, we document the most intense housing wealth effects occur in Colarado, Illinois, Massachusetts, New Hampshire, and Virginia in terms of the magnitude of the causality measure estimate. Again, no housing wealth effects are documented in Hawaii, Utah and Wyoming, and Pennsylvania has the strongest multi-horizon financial wealth effect. It is also important to note that we document significant wealth effects across different prediction horizons in the remaining states.
Our results lead to various implications. Housing/financial wealth effects show heterogeneity across U.S. states depending on the scope of the data (state vs. aggregate) and employed methodology. Furthermore, while non-causality testing suggests that financial wealth is as important as housing wealth, causality measurement clearly indicates that housing wealth has more statistically significant, persistent, and widespread impacts on consumption growth than financial wealth at both the state and the aggregate level. Our evidence of stronger state-level housing wealth effect confirms the results of [
5,
6,
8]. Our evidence is in line with the findings of [
1,
2,
3,
4,
43], among others, at the aggregate level. The dominance of the housing market in generating wealth effects upon consumption at the state level may be attributed to the relatively more uniform increase in housing value across regions compared to the quite unequal geographical distribution of stock market wealth across households in the U.S. (see, [
8]). This evidence has important implications for monetary policies aiming to develop a strategy combining asset prices, consumption, and price stability (see [
61]). Moreover, our findings suggest that federal/state level economic policies may define specific targets for consumption, saving, and economic growth depending on the magnitude of the wealth effect of the relevant state. For example, while housing economy may not be a priority in Hawaii, Utah, and Wyoming, both housing/financial ownership may be specifically supported in Pennsylvania. Moreover, the evidence on the presence of housing wealth effects upon consumption at long horizons is in line with the result of [
45], suggesting that housing markets are positively sensitive to long-run state-level policymaking.