Financial market and housing wealth effects on consumption: a permanent income approach

Abstract

The objective of this study is to examine the financial market and housing wealth effects on consumption. Housing has the dual functions as both a commodity yielding a flow of housing services and an investment asset yielding a flow of capital income. With the construction of an empirical framework based on the vector autoregression approach, the findings from this study suggest that a rise in housing price has both a positive wealth effect and a negative price effect on consumption. While the positive wealth effect is caused by an increase in capital income, the negative price effect is caused by an increase in the cost of housing services. In addition, the housing market wealth effect increases, at the expense of the price effect, with the level of housing-market leverage. These findings imply that the government policy of land supply aiming to stimulate the economy should strike a balance between the possible wealth and price effects of the housing market.

Acknowledgements

The work described in this article was substantially supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region (Project No. A-PC49). An earlier version of this article was presented at the 2003 Midwest Economics Association Meeting, St Louis, Missouri. The authors thank the anonymous referee for his/her helpful comments.

Notes

¹ The proportion of households owning private residential housing in Hong Kong is relatively small as compared to other developed economies – only ∼35–40% of the households in Hong Kong are property owners and nearly one third of them are living in public housing. As compared to over 70% in the US and UK, the homeownership rate in Hong Kong is relatively low.