Richard Berner on Declining Housing Demand and Consumer Spending

by: Richard Berner

Excerpt from Morgan Stanley's Chief US Economist Richard Berner's September 18th essay titled "The Great Housing Debate":

The decline in housing demand probably will crimp spending on furniture, appliances and other household goods such as carpeting and draperies. A 10% decline in such outlays over a year could knock another 0.3% off overall GDP. Moreover, it would be reasonable to think that the surge in housing wealth and home equity extraction has fueled significant spending gains in these discretionary items, that households can postpone such purchases, and that even a deceleration in housing wealth could promote declines in these big-ticket outlays.

Reasonable, yes, but not entirely accurate. First, housing activity and big-ticket housing-related durables don’t necessarily march in lockstep anymore. That’s partly because household electronics, such as TVs and audio equipment, computers and musical instrument comprise about 40% of such outlays, and innovation and the resulting obsolescence and price declines in such products drive rapid growth. As a result, we expect real growth in such outlays to decelerate sharply but not to contract.

Moreover, and most important, in my view the deceleration in housing wealth will have at most one-fifth the impact on consumer spending that some fear. Some, including former Fed Chairman Greenspan, believe that 50 cents of every additional dollar of home equity extraction has financed consumer outlays. Empirical studies, however, suggest that a $1 decline in real housing wealth would trim spending by at most 11 cents, and some suggest that the effect would be half that magnitude (see “Housing Wealth and Consumer Spending” and “Housing, Mortgages and Consumption: Comparing Australia, the UK and the US,” Global Economic Forum, October 7, 2005 and March 3, 2006, respectively). Of course, that’s not negligible; we estimate that the flattening in real housing wealth in our outlook will pare roughly ½ percentage point from the growth in consumer outlays over the coming year.

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