Falling stock prices depress consumption.

Standard models of intertemporal choice suggest that unexpected and permanent drops in wealth reduce consumption, and that this reduction equals the annuity value of the drop in wealth. There is, however, much disagreement about the magnitude of the impact of wealth shocks on consumption. Most of the literature attempting to estimate this impact is based on two implicit assumptions: (i) wealth shocks (whether due to house price changes or movements in stock prices) are not predictable, and therefore not anticipated by consumers; (ii) current prices are the best predictors of future asset prices, and therefore changes in asset prices constitute a permanent wealth shock. According to the permanent income hypothesis, it follows from (i) and (ii) that wealth shocks should have a relatively large impact on consumption, equivalent to the annuity value of the wealth shock (in the order of 2 to 5 percent, depending on the assumed real interest rate). Several studies, relying on macroeconomic or regional data, regress the logarithm of consumption, consumption growth or saving on shocks to housing or financial wealth, but no consensus has yet emerged on the link between house prices and consumption.3 Studies using microeconomic data allow researchers to dig deeper into this link. While changes in stock prices imply unambiguous wealth effects on consumption, as discussed in Sinai and Souleles (2005), Campbell and Cocco (2007) and Attanasio et al. (2009), the consumption response to a house price decline is quite heterogeneous across the population. Most empirical analyses using micro-data refer to the U.S. and the U.K. Engelhardt (1996) estimated an MPC of 0.03 or higher for the U.S. in the 1980s, and Juster et al. (2001) found an even higher MPC out of stock price changes. On the other hand, Hoynes and McFadden (1997) found that households who had experienced housing capital gains increased their saving rather than their spending, and Hryshko et al. (2010) find that after a job loss homeowners can smooth consumption easier than renters in times of higher house prices. In the UK Disney et al. (2010) find a relatively low MPC out of housing wealth (of the order of 0.01), while Campbell and Cocco (2007) a relatively strong response for older households that own their home. Attanasio et al. (2009) conclude that the co-movements in consumption and house prices are not generated by a causal link running from the latter to the former, but by common factors, contradicting the findings in Campbell and Cocco (2007).