We do not take an alarmist view on this {housing wealth effects}. However, there are some who feel that consumers react extremely strongly to changes, for example, in home equity line availability.

Our sense is that the relationship between home wealth and consumer spending is governed primarily by what's called the wealth effect, which suggests that, for each dollar that a house value falls, there's a net effect on consumer spending of somewhere between 4 cents and 9 cents, something like that.

So there is -- and that effect may be spread over a period of  time. So there would be an effect. But we see it as relatively moderate.

From the Q&A session.

Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time.  This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate.  These inferences are supported by some empirical evidence.¹⁰

[T]he so-called “wealth effect” that links increases and decreases in house prices with rises and falls in consumer spending may not be as strong as some analysts suggest.  In our estimation, the run-up in housing values over the past several years did not spur much of a bigger-than-expected increase in consumer spending — if anything, the response was a bit on the low side compared to the historical average. So we wonder about how large a spending effect one should expect to accompany a fall in housing prices, if that were to occur. Clearly mortgage equity withdrawals have been sizable during the housing “boom,” but many of these withdrawals were used to reduce other forms of consumer debt and to make one-time improvements in the housing stock.  Indeed, as a result, overall household balance sheets today continue to look fairly strong.

By 2030, almost one in five U.S. residents will be 65 years or older.  Well before then, beginning in about 2018, Social Security will start to pay out more in ben­efits than it receives from payroll taxes.  Even before that, -- in the neighborhood of 2010 -- Social Security will start exerting upward pressure on the unified federal budget deficit as its surplus diminishes, with a consequent reduction in net public saving, absent changes in the program itself, increased taxes, or reduced spending on other government programs.  

The situation for Medicare is similar and, potentially even more serious.  Payroll taxes to cover Medicare expenditures are currently in surplus.  Over time, however, Medicare spending is expected to increase more rapidly than related tax revenues, creating a deficit prob­lem that analysts see as potentially greater in size and more difficult to deal with than that associated with Social Security.   Thus, despite the relatively benign federal deficit we currently see, it is clear the situation will worsen dramatically over the next decade.  And, unlike the late '80s when deficits became a national concern, there seems to be no political consensus on the nature of this problem or its resolution -- a fact that should be a concern to all of us.

The big question for the economy though is what sort of spillover effects we're going to get. There's this hypothesis floating around, this conjecture, about whether the slowdown in housing price appreciation will cut into consumer net worth and lead them to do sort of a reverse wealth effect reduce spending growth. And we haven't, I don't think, really seen that thus far.

It is difficult to dismiss the conclusion that a significant amount of consumption is driven by capital gains on some combination of both stocks and residences, with the latter being financed predominantly by home equity extraction. If so, leaving aside the effect of equity prices on consumption, should mortgage interest rates rise or home affordability be further stretched, home turnover and mortgage refinancing cash-outs would decline as would equity extraction and, presumably, consumption expenditure growth. The personal saving rate, accordingly, would rise. Carrying the hypothesis further, imports of consumer goods would surely decline as would those imported intermediate products that support them. And one would assume that the U.S. trade and current account deficits would shrink as well, all else being equal.

The housing boom will inevitably simmer down...As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures.

The surprisingly high correlation between increases in home equity extraction and the current account deficit suggests that an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit. Whether those adjustments are wrenching will depend...the degree of economic flexibility that we and our trading partners maintain, and I hope enhance, in the years ahead.

Historically, it has been rising real long-term interest rates that have restrained the pace of residential building and have suppressed existing home sales, high levels of which have been the major contributor to the home equity extraction that arguably has financed a noticeable share of personal consumption expenditures and home modernization outlays.

I don't expect that the personal saving rate will stay down this low indefinitely...There is a very significant amount of extraction of equity from homes in this country, financed by mortgage debt...That is a major factor creating the low level of savings.  And when equity extraction slows down, as it eventually will at some point, I think you will find this personal saving rate starting back up.