But are they right to worry? Superficially, it seems so. Changes in house prices have been closely associated with changes in consumer spending for years; the correlation between two-year changes in the two over the last 30 years has been 0.5. This suggests that if or when the house price boom turns to bust consumer spending will fall.
Or will it? Correlation is not causality. It could be that house prices and spending have fallen together not because one causes the other, but because both are driven by the same things, such as incomes (and income expectations) and interest rates.
Indeed, common sense says house prices shouldn’t matter for spending because, taking all of us together, housing isn’t wealth. Sure, a drop in average house prices would hurt home-owners who are looking to trade down – say, because they regard their house as part of their pension fund. But those of us who don’t intend to move aren’t affected by house prices: my car has lost value since I bought it but this doesn’t affect my spending so why should a change in the price of my other consumption goods? And for others – such as my colleague Katie Morley - falling house prices would actually make them better off, because they’d finally be able to buy a place or at least benefit from lower rents. For these reasons Willem Buiter – now chief economist at Citibank – once famously said that housing isn’t net wealth at all.
Econometric work at the IFS has confirmed this. Researchers there have found that spending by young people is correlated with moves in house prices whilst that of older people is much less so. This is inconsistent with the idea that changes in housing wealth drive consumer spending – because older folk have more expensive houses than youngsters and so should, in theory, respond more to changes in house prices.
One reason for this might be that house prices are measuring expected future incomes; house prices rise if expected incomes do. This should raise spending by younger people more than oldsters simply because younger folk have more future in front of them. If this is the case, we shouldn’t worry about a fall in house prices caused by a pure bursting of the “bubble” (a word I find unhelpful), as this wouldn’t betoken a fall in expected incomes.
Another possible reason is stressed by Oxford University’s John Muellbauer. A fall in house prices matters, he says, not because it reduces wealth but because it reduces the collateral which we can put up against loans. It therefore reduces spending because it reduces our ability to borrow. Because younger home-owners are more credit-constrained than older ones, this implies that younger people's spending should respond more to changes in house prices.
This too suggests we shouldn’t worry very much about a drop in house prices, simply because a lot of people are credit-constrained already. Whether because of their high debts, or banks’ reluctance to lend, they can’t borrow anyway. So a drop in collateral won’t matter.
So, does all this mean the “great and good” are wrong to fret about the risks from falling house prices? Maybe not. A fall in house prices – unless accompanied by bad economic news - might not matter very much for household spending in aggregate. But it could lead to increased bad debts at banks and hence to a general downturn as they rein in their lending. In this sense, the threat to financial stability comes not from ordinary people, but from banks. But then, anyone who isn’t blinded by ideology has known this for some time.
