Martin Wong
Reserve Bank of New Zealand
Wellington, March 31, 2017
Understanding the link between changes in wealth and household consumption is crucial to the Reserve Bank of New Zealand’s assessment of business cycle dynamics.
In the Bank’s pursuit of price stability, changes in the policy rate influence household spending in part via their impact on asset prices and wealth.
Recent trends have prompted a reassessment of the relationship between household spending and wealth. Since the global financial crisis (GFC), per capita consumption growth in New Zealand has been modest even as housing wealth has been rising rapidly.
Increase in savings
The modest growth in per capita consumption has coincided with an increase in the household saving rate, a slowing in credit growth, and a positive injection of equity into the housing sector by households.
This Analytical Note estimates the response of household consumption (its elasticity) with respect to housing and financial wealth, and income between 1982 and 2016. To examine the stability of the relationship, the model is also re-estimated across a split sample. The results suggest that there has been a change in the relationship between household consumption and wealth. It finds:
On a dollar for dollar basis, consumption appears to respond more to changes in financial wealth than fluctuations in housing wealth over the full sample;
The response of consumption to wealth has fallen in the sample after 2005, particularly the response with respect to housing wealth.
Analytical Notes
Future capital gains
The change in the response of household consumption to wealth could reflect a reassessment of expected future capital gains from each form of wealth following the GFC, particularly given heightened uncertainty in the housing market. It may also reflect a desire by highly indebted households to pay down debt, along with the influence of low interest rates, indicating a prolonged but transitory period of deleveraging and higher savings. Disentangling the aforementioned factors is beyond the scope of this note but could usefully be addressed with cross-sectional data at the household level.
Housing wealth has increased rapidly in recent years but relative to the 1990s and 2000s, the response of per capita household spending has been weaker than expected.
This Analytical Note estimates a long-run cointegrating relation between household consumption, housing wealth, net financial wealth and income to examine this recent dynamic.
Cointegration Model
The cointegration model suggests that both the consumption elasticity of housing wealth and the propensity to consume out of housing wealth is lower in the post-2005 period. The elasticity and MPC of net financial wealth is also lower in the sample after 2005, but to a lesser extent. The findings for housing wealth are largely robust to an alternative method proposed by Carroll et al. (2011) which accounts for potential
long-run instability in the assumed cointegrating relationship.
A key contribution of the analysis is that it incorporates improved household balance sheet and national accounts data, and an up-to-date sample incorporating observations since the GFC. The approach recognises the importance of household balance sheet data in accounting for evolving credit and wealth relationships when assessing the trend in household spending.
Future analysis could involve examining the consumption-wealth dynamic using cross-sectional data at the household level to isolate certain characteristics regarding demographics, wealth, income, and debt levels. Disentangling the underlying drivers may shed light as to whether or not the response of consumption to wealth will revert to the relationships observed in previous cycles.
Martin Wong is Senior Analyst in the Policy Analysis Team in the Economic Department of Reserve Bank of New Zealand based in Wellington. The above is only a part of the Analytical Notes titled, ‘Revisiting the Wealth Effect on Consumption in New Zealand’ published today. For full text, please visit www.rbnz.govt.nz
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