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Working Paper no. 272
Over much of the past 25 years, the cycles of house price and consumption growth have been closely synchronised. Three main hypotheses for this co-movement have been proposed in the literature. First, that an increase in house prices raises households' wealth, which increases their desired level of expenditure. Second, that house price growth increases the collateral available to homeowners, reducing credit constraints and thereby facilitating higher consumption. And third, that house prices and consumption have tended to be influenced by common factors (eg productivity growth or tax changes), which cause revisions to households' expected lifetime income. This paper uses individual household level data to assess the importance of these different hypotheses. Revisiting this link seems particularly timely, as the housing market has cooled since the end of 2004, generating widespread press speculation about the outlook for prices. In addition, there is the puzzle, discussed in a box in the Bank of England's Inflation Report in November 2004, about the...