Decomposing Consumer Wealth Effects: Evidence on the Role of Real Estate Assets Following the Wealth Cycle of 1990-2002

During the period of 1990-2002 US households experienced a dramatic wealth cycle, induced by a 369% appreciation in the value of real per capita liquid stock market assets followed by a 55% decline. However, consumer spending in real terms continued to rise throughout this period. Using data from 1990-2005, traditional life-cycle approaches to estimating macroeconomic wealth effects confront two puzzles: (i) econometric evidence of a stable cointegrating relationship among consumption, income, and wealth is weak at best; and (ii) life-cycle models that rely on aggregate measures of wealth cannot explain why consumption did not collapse when the value of stock market assets declined so dramatically. We address both puzzles by decomposing wealth according to the liquidity of household assets. We find that the significant appreciation in the value of real estate assets that occurred after the peak of the wealth cycle helped sustain consumer spending from 2001 to 2005.