UBS Explains How Increasing Home Prices Boosts Consumer Spending

Bronx old houses

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The crash of the U.S. housing market was absolutely devastating for the economy.Unfortunately, the rebound in the market is unlikely to benefit the economy in the same proportions, writes UBS economist Maury Harris.  From Harris’s note to clients:

After declining for a half decade, US home prices have started to recover. There is a likely asymmetry between the dramatic economic damage from the preceding home price crash and the probably more limited potential economic contribution from further home price recovery.

So, how much would rising home prices benefit the consumer and ultimately the economy? Harris explains:

How much would a $1 trillion swing in the change in housing wealth influence consumer spending? Housing economists have estimated that a 10% change in housing wealth can affect personal consumption expenditures by between 0.3% and 1.8%, with 0.8% being in the middle of this range. Per these estimates, a $1 trillion or around 6% change in housing wealth could raise annualized personal consumption expenditures by around 1⁄2 percentage point. However, we view this estimate as probably too high, since the historical wealth effects were estimated over a time span including many years when there was significant home equity extraction via cash out refinancing and home equity loans—two financing avenues that are far more restricted in the current post housing crash environment.

But there are a lot of uncertainties that are difficult to account for:

That said, there could be hard-to-measure but likely positive consumer sentiment effects for most American homeowners no longer observing continued home price declines. Also, from the perspective of homebuilders, recovering home prices should stimulate housing production.

At this point, Harris and his team sees improving home prices boosting the U.S. economy.  For the year, they see GDP expanding 2.1 per cent and 2.3 per cent in 2013.

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