Do our personal experiences of local house price growth influence our consumption decisions?

By Benjamin Appianin, CERF/CCFin Research Associate, Cambridge Judge Business School, University of Cambridge

Experiencing higher local house price growth leads to increased consumption by households

With household consumption trailing its pre-recession levels for years after the Great Recession despite improvement in household balance sheets, it is essential to investigate whether past experiences with economic variables continue to influence consumer behaviour.

Using household-level data on expenditure on nondurables and services, I find that households significantly increase their consumption when they have personally experienced higher house price growth in the places they live. This effect is pronounced for homeowners and, surprisingly, for renters. Younger renters, in particular, spend more on food than older renters when experiencing higher house price growth in their locality.

Consistent with existing evidence, I find that homeowners expect higher future home price growth, and renters are less likely to transition from renting to homeownership when experiencing higher house price growth, hence the increase in consumption of nondurables and services. 

Experience effect has been shown to play a significant role in expectations formation and intertemporal decision-making of households, including stock return and inflation expectations, home price and unemployment expectations, stock market participation, home search behaviour, and whether to rent or buy a home. Despite these nascent studies, given the importance of the housing market in households’ consumption decisions through the traditional housing wealth and collateral channels, the issue of whether experienced house price growth affects household consumption is yet to be studied. 

Computing experienced house price growth

This study is based on US households in the 1999 to 2019 Panel Study of Income and Dynamics (PSID) survey. The final sample covers 6,357 unique households in 923 unique counties across the 50 US states and the District of Columbia. 

To compute the experienced house price growth of the PSID households, I use county-level house price growth data from the Federal Housing Finance Agency (FHFA) and merge it with the PSID data based on the households’ county of residence codes each year. The experienced house price growth is then computed as the exponentially weighted average of the past 4 years’ house price growth in the household’s county. Thus, based on existing evidence, I assume households learn and recall their local house price growth over the past four years and also remember most recent house price growth realisations better than earlier house price growth realisations.

Empirical design

To begin my analyses, I hypothesise that experienced house price growth significantly influences households’ consumption. The challenges with identifying the experience effect are that unobserved local time-varying factors, such as productivity and income expectations, could influence both house price growth and household consumption, raising potential endogeneity issues. Also, experienced house price growth might affect household consumption through housing wealth and collateral channels, confounding the experience effect.

To alleviate these concerns, I instrument for the local house price experiences of households with the local house price experiences of extended family members in geographically distant housing markets. I also rule out several alternative explanations, including risk-sharing between households and geographically distant families, bequest motives, and boom-bust asymmetry in local housing markets.

Key findings: an increase in consumption

The main findings are that households who have experienced higher house price growth in their county increase their consumption by about 6.3 to 7.3 percentage points than households who have experienced lower house price growth in their locality, all other things being equal. This effect corresponds to an increase in real annual spending of households by about $2,163 to $2,680 (2019 US dollars).

Even within the same household over time, higher experienced house price growth leads to increased household consumption by 1.6 to 2.0 percentage points, corresponding to an increase in real annual spending of the households by about $536 to $715. 

Differences in spending by household characteristics

To examine which households are more likely to increase their spending when experiencing higher local house price growth, I examine various spending heterogeneity by household characteristics. 

Comparing the spending of homeowners and renters in response to experienced house price growth, the study finds no significant difference between the spending propensity of homeowners and renters. This finding also helps to alleviate concerns that housing wealth and collateral channels confound the interpretation of my findings as experience effects. That is, if housing wealth and collateral effects are the underlying mechanisms, we should have seen a higher response from homeowners relative to renters. Leaning further into renters’ consumption behavior, the study finds that their food spending decisions largely drive the effect, and younger renters spend more on food than older renters when experiencing higher local house price growth. 

The study also examines spending heterogeneity across the education level and the age of the household head. The findings show no significant difference in spending between college-educated households and non-college-educated households in response to experienced house price growth. Also, the effect of experienced house price growth on consumption is not significantly different between younger and older households. This finding is consistent with existing evidence on extrapolative experience-based learning, where experience effects are not age-dependent.

Why would households increase their consumption when experiencing higher local house price growth?

Having established the significant role of experienced house price growth in the consumption decisions of households, the next question that arises is why households would increase their consumption when experiencing higher local house price growth.

Consistent with existing evidence, the study shows that homeowners expect growth in future home prices when experiencing higher local price growth. This finding suggests optimistic beliefs about future home price gains, fueling the decision of homeowners to increase consumption. 

Renters, on the other hand, are less likely to transition from renting to homeowning when experiencing higher local house price growth and hence increase spending on other things like nondurables and services consumption. This finding aligns with recent anecdotal evidence that younger generations are ‘doom spending’ on nice things to make them happy because home prices are out of reach.