The Life-cycle Effects of House Price Changes

Abstract

We develop a life-cycle model to study the effects of house price changes on household consumption and welfare. The model explicitly incorporates the dual feature of housing as both a consumption good and an investment asset and allows for costly adjustments in housing and mortgage positions. Our analysis indicates that although house price changes have small aggregate effects, their consumption and welfare consequences on individual households vary significantly. In particular, the non-housing consumption of young and old homeowners is much more sensitive to house price changes than that of middle-aged homeowners. More importantly, while house price appreciation increases the net worth and consumption of all homeowners, it only improves the welfare of middleaged and old homeowners. Young homeowners and renters are worse off due to higher life-cycle housing consumption costs.

On the user cost and homeownership

“…3 This assumption simplifies the computation of the model. See Li and Yao (2007) for an alternative model with refinancing costs. 4 See Campbell and Cocco (2003) for a discussion of optimal mortgage choice.…”

“…Retirees receive a pension proportional to permanent earnings in the last period of their working life. That is, for a household born at time 0, w t = bP R , ∀t > R. 6 Housing prices are uncertain and following Li and Yao (2007), we assume that house price appreciation follows and i.i.d. normal process: q t /q t−1 − 1 = t , with t ∼ N(μ , σ 2 ).…”

“…μ = 0 and σ 2 = 0.0132 (as in Li and Yao, 2007 and within the estimates of Goetzmann and Spiegel, 2000). For simplicity, we assume An important part of our calibration is the rental price.…”

“…Ortalo-Magné and Rady (2002) demonstrate that homeownership is an effective way of isolating housing consumption against income risk. The studies most closely related to ours are Chambers et al (2005), Li and Yao (2007), and Bajari et al (2005). Chambers et al (2005) study tenure choice in a general equilibrium model in which households can be renters and owners at the same time but abstract from price changes, taxation issues and home equity loans.…”

“…Chambers et al (2005) study tenure choice in a general equilibrium model in which households can be renters and owners at the same time but abstract from price changes, taxation issues and home equity loans. Li and Yao (2007) also abstract from taxation issues and focus on the welfare effects of price appreciations. Bajari et al (2005) focus on the welfare consequences of home price appreciation as well and show that price appreciation results in large wealth transfers across households and modest aggregate effects on welfare.…”