Household Leverage and the Housing Wealth Effect Jonathan Chiu, - PowerPoint PPT Presentation

. Household Leverage and the Housing Wealth Effect Jonathan Chiu, Robert Kirkby, Karam Shaar, Fang Yao Victoria University of Wellington (Chiu, Kirkby, Shaar) Reserve Bank of New Zealand (Yao) December 11, 2017

. 1 policy, as well as the broader economy in New implications for monetary and macroprudential recent years, along with household leverage. Kaplan, Mitman and Violante (2016) – Dynan (2012), Mian, Rao and Sufj (2013), leading to recession. especially those who were heavily leveraged, led people to cut back on consumption, sheets. important components of household balance Zealand. Motivation • Housing debt and housing wealth have become • Great Recession in the US: Falling house prices • New Zealand: House prices have risen rapidly in • Rising leverage and house prices may have

. 2 Research question Does household indebtedness (leverage) make consumption expenditure more or less sensitive to changes in housing wealth? Zealand to estimate the consumption elasticity out of exogenous changes in housing wealth, controlling for the efgect of leverage. empirical fjndings. Household Leverage and the Housing Wealth Effect • Empirically, we use microdata from New • We build a life-cycle model to interpret the

. sensitive to housing wealth changes factors other than borrowing constraint matter – interpretation: the efgect can be asymmetric; to housing wealth changes – high leverage makes consumption less sensitive Our paper: – interpretation: binding borrowing constraints – high leverage makes consumption more 3 Conventional view: changes in housing wealth? consumption expenditure more or less sensitive to Does household indebtedness (leverage) make Research question too, especially in a housing boom. Findings

. sensitive to housing wealth changes factors other than borrowing constraint matter – interpretation: the efgect can be asymmetric; to housing wealth changes – high leverage makes consumption less sensitive Our paper: – interpretation: binding borrowing constraints – high leverage makes consumption more 4 changes in housing wealth? consumption expenditure more or less sensitive to Does household indebtedness (leverage) make Research question too, especially in a housing boom. Findings • Conventional view:

. sensitive to housing wealth changes factors other than borrowing constraint matter – interpretation: the efgect can be asymmetric; to housing wealth changes – high leverage makes consumption less sensitive – interpretation: binding borrowing constraints – high leverage makes consumption more 5 changes in housing wealth? consumption expenditure more or less sensitive to Does household indebtedness (leverage) make Research question too, especially in a housing boom. Findings • Conventional view: • Our paper:

. 6 Outline • Empirical results • Intuitions from a two-period model. • Numerical results from a richer model.

. 7 Economic Survey (HES) data from Stats NZ. 2009-10, 2012-13, 2015-16. debt for 16,000 households. household level (HES) and house price micro data at local level. education, composition of household, etc. Empirical Analysis • Microeconometric study using Household • Repeated cross-sectional data for: 2006-07, • HES reports consumption spending, income, and • House price data: periodic rateable value at • Also many demographic variables; age, gender,

. mies Yes Yes Yes Time dummy Yes Yes Yes Yes Household dum- Yes dummy Yes Yes Yes Observations 5134 4644 4644 3792 0.56 0.57 0.58 Yes Regional 8 Income Total exp. Total exp. Non-durable Durable Housing wealth 0.14 Regression I • Baseline regression equation: log ( CE i ) = β 0 + β 1 log ( Y i ) + β 2 log ( HP i , au ) + β 3 Z i + u i 0 . 08 ∗∗∗ 0 . 17 ∗∗∗ 0 . 15 ∗∗∗ 0 . 22 ∗∗∗ (0 . 03) (0 . 02) (0 . 02) (0 . 05) 0 . 40 ∗∗∗ 0 . 40 ∗∗∗ 0 . 36 ∗∗∗ 0 . 60 ∗∗∗ (0 . 02) (0 . 02) (0 . 02) (0 . 08) Adj- R 2

. . 9 . Leverage Effect: First Impression Figure : (Clustered) Data Scatter Plot 15 14 expenditure per person 13 12 11 8 9 10 11 12 house value Low Leverage LTV Low High Leverage LTV High

. Housing Age*LTV*Housing Controls Yes Yes Yes Yes Obs - LTV*Housing - 10 LTV - - iv ii iii i Dependent variable Log non-housing expenditure Regression II • Regressions with leverage: log ( C i ) = β 0 + β 1 log ( HP au ) + β 2 LTV i + β 3 LTV i ∗ log ( HP au ) + β 4 log ( Y i ) + β 5 Z i + u i 0 . 14 ∗∗∗ 0 . 19 ∗∗∗ 0 . 18 ∗∗∗ 0 . 14 ∗∗∗ (0 . 04) (0 . 05) (0 . 05) (0 . 04) − 0 . 19 ∗∗∗ 2 . 02 1 . 62 (0 . 05) (1 . 23) (1 . 2) − 0 . 17 ∗ − 0 . 16 ∗ − 0 . 04 ∗∗∗ (0 . 10) (0 . 09) (0 . 01) 0 . 0005 ∗ 0 . 0006 ∗∗ (0 . 00) (0 . 00) 1853 1853 1849 1849 Adj. - R 2 0 . 552 0 . 554 0 . 556 0 . 555

. 11 households are less sensitive to house prices. the fjndings of Mian, Rao, and Sufj (2013). between leverage and housing wealth efgect is asymmetric. empirical fjndings. Summary and Next Step • We fjnd that consumption of highly leverage • Our empirical result is surprising in the light of • One possible explanation: the interaction • We build a life-cycle model to understand the

. max p h . where: subject to problem: Consider a household who faces the following 12 . A Two-Period Model C 1 , C 2 , A 1 u ( C 1 ) + β u ( C 2 ) , u ( C ) = C 1 − ρ 1 − ρ = C 1 + A 1 A 0 ≥ − µ V p h A 1 1 H 2 H + A 1 R = C 2

. 13 Analytical Solution • Case 1: A 1 = − µ V p h 1 H ¯ C 1 = A 0 + µ V p h 1 H . • Case 2: A 1 > − µ V p h 1 H 1 1 = A 0 − Ψ A 0 − p h 2 H C ∗ . Ψ + R 1 where Ψ = [ β R ] ρ .

. 14 consumption/saving decision of unconstraint H dp h dp h larger. H dp h households versus low leverage is given by the following equation: Proposition 1 : In this two-period model, the difgerence between MPCs of households with high Analytical Result ∆ MPC | LTV = ∂ ¯ − ∂ C ∗ C 1 1 2 = µ V H − dp h Ψ + R ∂ p h ∂ p h 1 1 1 • µ V H captures the borrowing constraint efgect. A higher µ V makes MPC of constraint households • 2 Ψ+ R comes from the optimal 1

. dp h . 15 dp h h H h . dp The Role of House Price Dynamics 2 ∆ MPC | LTV = µ V H − dp h 1 ρ + R ( β R ) 1 • When dp h 1 < 0 , ∆ MPC | LTV > 0 2 • When dp 1 > 0 and large enough, ∆ MPC | LTV < 0 2

. 16 consumption-smoothing incentive is stronger relative to future consumption. This incentive to increase current consumption are both high, an unconstrained agent has an when agents are more risk averse. dp h The Role of Risk Aversion ( ρ ) ∂ ∆ MPC | LTV H Ψ 1 2 = − dp h ln [ β R ] (Ψ + R ) 2 ρ 2 ∂ρ 1 1 > 0 and R > 1 • When dp h 2 / dp h β , then a higher ρ implies a smaller ∆ MPC | LTV . • When future house price and returns to saving

. 17 agents make decision to save/borrow using a combination of housing, debt, and fjnancial assets. housing-consumption utility and it serves as collateral for borrowing. housing and fjnancial markets. stationary equilibrium and transition path given a process of house prices. A Richer Model • A life-cycle model in which heterogeneous • Housing is desirable as it generates a fmow of • The model is partial equilibrium in terms of • We solve the model numerically, both for the

. 0.07 - - Age*Leverage*Housing Wealth -0.06 -0.02 - Leverage*Housing Wealth -0.55 -0.58 -0.84 Leverage 0.07 18 0.07 Housing Wealth iii ii i Consumption Dependent variable simulated panel data from the model. analysis performed in the empirical analysis on 0.00 Numerical Results I • We begin by running the same regression

. 19 efgect A: Efgect of Changing House Prices B: Efgect of Risk Aversion Numerical Results II Figure : Interaction between leverage and housing wealth

. 20 housing leverage and the housing wealth efgect. the boom phase of the housing cycle. empirical fjnding. the housing wealth efgect can be asymmetric. Besides borrowing constraint, the optimal behavior of unconstrained households also matters. Conclusions • This paper investigates the interaction between • We fjnd a difgerent pattern of the interaction in • We use a theoretical model to interpret the • We show that interaction between leverage and

. 21 Life Cycle of Leverage Figure : Share of High LTV in Age .6 share of high LTV households .4 .2 0 20 40 60 80 age