Housing, Debt, and the Marginal Propensity to Consume

Abstract      

We analyse how housing and mortgage debt affect households’ marginal propensity to consume out of wealth. Using detailed Norwegian registry data, we document that after controlling for wealth, households with higher leverage respond more to wealth changes. Hence, for the purpose of understanding household consumption dynamics, total wealth is an insufficient statistic to summarize household balance sheets. We therefore develop a structural model that can account for mortgage debt over the life cycle and its relation to consumption choice. In our model households hold debt, financial assets and illiquid housing. The marginal propensity to consume out of wealth is declining, as in a standard single-assets consumption model, but not monotonically households who have recently bought houses have high leverage and high marginal propensity to consume. Our estimated model successfully targets the life cycle profiles of household balance sheets in the micro data. As a test of external validity, we show that regressions from data simulated by the model give results consistent with regressions on the actual registry data. Our findings corroborate the view that household indebtedness and leverage matter for consumption dynamics, that a substantial fraction of households are likely to behave in hand-to-mouth fashion even though their wealth is high, and that the housing market is key to these phenomena.