The differing impacts of financial and housing wealth on consumption: The case of Canada

The recent 2007-2009 financial crisis originated in the housing market and then quickly spread to the financial market. The resulting deep recession was felt worldwide and caused a strong decline in the consumption of many countries. Interestingly, Canada fared better compared to other developing countries. One possible explanation for this is that the country had gone through extensive housing market reforms a decade earlier, rendering the housing component of Canadians’ wealth more stable than their financial wealth. These observations demonstrate the need for understanding the immediate and the more enduring quantitative impacts of changes in different types of wealth on consumption.

In this paper we therefore study the effects of financial and housing wealth on short and long term consumption in Canada. For this purpose, we make use of the modelling framework of Carroll, Otsuka and Slacalek (2011) who exploit consumption stickiness to characterize a relationship between marginal propensity to consume and wealth that they then estimate using Generalized Method of Moments. As available data samples for Canada are relatively short, and as there is considerable endogeneity in the relationship that needs to be accounted for, we conduct our estimations and inference using econometric methods that, unlike Generalized Method of Moment, are robust to identification difficulties.

Our results show that different wealth types do have different impacts on the marginal propensities to consume. In particular, financial wealth has on average a much bigger impact than housing wealth. However, we also find that considerable estimation uncertainty associated with the obtained estimates.