Housing, Debt and the Marginal Propensity to Consume

We analyze how housing and mortgage debt affects households’ marginal propensity to consume. Using detailed Norwegian register data, we document that after controlling for wealth, households with higher leverage increase consumption more when their wealth changes. Hence, for the purpose of understanding household consumption dynamics, wealth is an insufficient statistic to summarize household balance sheets. We therefore develop a structural model to account for how household accumulate mortgage debt over the life cycle, and how this affects 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 asset consumption model, but not monotonically so: households who have recently bought houses have high leverage and high marginal propensities to consume. We estimate the model to account for the life cycle profiles of household balance sheets in the micro data. Regressions from data simulated by the model give results consistent with regressions on the actual register 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 a “hand-tomouth” fashion even though their wealth is high, and that the housing market is key to these phenomena.