Consumption, House Prices and Collateral Constraints

Abstract

If borrowing capacity of indebted households is tied to the value of their home, house prices should enter a correctly specified aggregate Euler equation for consumption. I develop a simple two-agent, dynamic general equilibrium model in which home (collateral) values affect debt capacity and consumption possibilities for a fraction of the households. I then derive and estimate an aggregate consumption Euler equation, and estimate its structural parameters. The results provide robust support for housing prices as a driving force of consumption fluctuations.