TY - JOUR AU - Berger, David AU - Guerrieri, Veronica AU - Lorenzoni, Guido AU - Vavra, Joseph TI - House Prices and Consumer Spending JF - National Bureau of Economic Research Working Paper Series VL - No. 21667 PY - 2015 Y2 - October 2015 DO - 10.3386/w21667 UR - http://www.nber.org/papers/w21667 L1 - http://www.nber.org/papers/w21667.pdf N1 - Author contact info: David W. Berger Department of Economics Duke University 419 Chapel Drive Social Science Building 231 Durham, NC 27708 Tel: 919/660-1853 E-Mail: david.berger@duke.edu Veronica Guerrieri University of Chicago Booth School of Business 5807 South Woodlawn Avenue Chicago, IL 60637 Tel: 773/834-7834 Fax: 773/702-0458 E-Mail: vguerrie@chicagobooth.edu Guido Lorenzoni Department of Economics Northwestern University 2211 Campus Dr Evanston, IL 60208 Tel: 847/491-8243 E-Mail: guido.lorenzoni@northwestern.edu Joseph S. Vavra Booth School of Business University of Chicago 5807 South Woodlawn Avenue Chicago, IL 60637 Tel: 773/834-0959 E-Mail: joseph.vavra@chicagobooth.edu AB - Recent empirical work shows large consumption responses to house price movements. This is at odds with a prominent theoretical view which, using the logic of the permanent income hypothesis, argues that consumption responses should be small. We show that, in contrast to this view, workhorse models of consumption with incomplete markets calibrated to rich cross-sectional micro facts actually predict large consumption responses, in line with the data. To explain this result, we show that consumption responses to permanent house price shocks can be approximated by a simple and robust rule-of-thumb formula: the marginal propensity to consume out of temporary income times the value of housing. In our model, consumption responses depend on a number of factors such as the level and distribution of debt, the size and history of house price shocks, and the level of credit supply. Each of these effects is naturally explained with our simple formula. ER -