Friday, July 04, 2008

House Prices vs. Consumer Spending

by Calculated Risk on 7/04/2008 05:47:00 PM

The Economist has an interesting discussion on changes in real house prices vs. changes in real consumer spending, see: Collateral damage

Note: the following graph is from the Economist article and is for the UK.

U.K. Real House Prices vs. Real Consumer Spending

For many years it was taken for granted that there was a strong relationship between house prices and consumer spending (see chart). More recently the Bank of England has cast doubt on the link.

The apparent breakdown in the relationship in the early years of this decade, when consumers did not respond to a surge in house prices by spending more, seemed to support the central bank’s view. This year too, shoppers appear unfazed by falling property wealth. Household spending rose by 1.1% in the first quarter of 2008 compared with the last three months of 2007. Official figures for retail-sales growth in May were so buoyant that they aroused incredulity in the City.
According to Ray Barrell of the National Institute of Economic and Social Research, a 15% decline in house prices over the next two years would reduce the increase in consumer spending by one percentage point a year.
U.S. Real House Prices vs. Real Consumer Spending Click on image for larger graph in new window.

The second graph compares the Year-over-year (YoY) change in real personal consumption expenditures (PCE) vs the YoY change in house prices in the U.S. (only since 1987). Note that this graph is plotted using the same vertical scales as the U.K. graph.

Although there appears to be some relationship between the YoY change in real consumer spending (as measured by PCE) and the YoY change in real house prices - the relationship hasn't been as tight as for the U.K. There are other factors that impact consumer spending, like changes in real income and changes in other asset values (like the stock market boom and bust).

Still - it is very likely that PCE will be negative later this year in the U.S. after the impact of the stimulus package is over.