The effect of house prices on private consumption in Denmark

Darina Todirica & Olga Molotkova Thr├Žn

Student thesis: Master thesis


This paper is inspired by the heated debate in the media and academia around the house market developement and its effect on the real economy. Some international empirical studies point towards the changed strength of the relationship between housing wealth and consumption; for Denmark such empirical evidence is very limited and is mostly based the relationship between total, not disaggreagted, wealth and consumption. Complementing Neoclassical Economics with Behavioral Economics (LC-PIH with Keynesian approach of rational consumer choice) we are able to recognize that private consumption may react differently to asset-specific wealth components. We find several theoretical explanations of how aggregate consumption can be affected by changes in real house prices on the short and long run (housing wealth effects). We identify several factors that could favour or work against the positive housing wealth effects: (a) the negative income and substitution effects on non-homeowners; the positive income effect on homeowners, (b) the capital losses of mortgage bond holders and the capital gains of borrowers as a result of refinancing, (c) unrealized wealth effect, (d) rental market imperfections, (e) unexpected permanent shocks, (f) shifts in expectations and preferences, and (g) interest rate changes effect on consumption-saving decisions of borrowers and lenders. The relative strength of these factors defines the magnitude of the housing wealth effects for any specific country and time period. Having examined these factors for Denmark qualitatively, we find that they to a large extent have been developing in favour of positive housing wealth effects. This assumption is supported by our empirical estimation that finds a significant positive housing wealth effect on private consumption in Denmark both in the long and short run. The marginal propensity to consume of housing wealth and financial wealth are found to be very close, which can be explained by the properties of these two wealth classes in our analysis: (a) pension savings that are included in our definition of financial wealth and constitute a large fraction of it has likely decreased the MPC of financial wealth; (b) factors favouring significance of positive housing wealth effects in Denmark have increased the MPC of housing wealth. The link house price-consumption-aggregate demand is an important factor to consider when formulating current fiscal stabilization policy. The indirect effect of reduction of interest rate tax deductibility can accelerate the decline in housing demand and offset the positive effect of labour income tax relief on private consumption.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2009
Number of pages144