CEBI research forthcoming in JEEA, Journal of the European Economic Association
House prices and spending move together but little is known about the underlying mechanism linking them. Søren Leth-Petersen and Henrik Yde Andersen design a test to discriminate between the housing wealth effect hypothesis and the collateral effect hypothesis.
The wealth effect hypothesis says that homeowners consider home value changes as windfalls and the collateral effect says that a home value increase generate additional collateral which can be borrowed against. They find that homeowners who are close to their collateral borrowing constraint take out new mortgage loans and increase spending when home values go up.
The effect is magnified among fixed rate mortgage borrowers who have an incentive to refinance their loans to lock in a lower market rate. These results show that the collateral effect is important for explaining the link between house prices and spending. They also emphasize that the price effect is magnified among fixed rate mortgage (FRM) borrowers who have an incentive to refinance their loans to lock in a lower market rate.
These results point to the importance of the mortgage market in transforming price increases into spending and suggest that monetary policy can play an important role in transforming housing wealth gains into spending by affecting interest rates on mortgage loans.
and the CEBI research story here