Earlier in this thread we mentioned Ricardian Equivalence, this theory holds that there is equivalence between government debt and taxes, or in other words that economic effects come from government spending, not how that spending is financed. BTW, this thread believes that Ricardian equivalence is approximately true. Ricardian equivalence is part of a larger theory of household/economic agent behavior known as the permanent income/lifecycle hypothesis (PILCH) and, in fact, can be regarded as the logical extension of that theory in the presence of government purchases, taxes, and debt.
Concisely, these individual but complementary theories assert that people base consumption on what they consider their "normal" income and smooth out (consumption smooth) short-term fluctuations (shocks). The life-cycle hypothesis introduced asset holdings as an important determinant of consumption patterns and specified that the average individual will attempt to schedule consumption based upon their total expected lifetime income.
Given that these hypotheses are approximately true, we should observe that as asset prices rise the typical asset holding economic agent would begin to increase consumption at some later point and, given consumption smoothing, we should expect this increase to be much less then the rise in the asset price. And in fact, this is what is observed:
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Hopefully, this will dispel the fears that asset holders are basing their consumption patterns entirely on recent gains in real estate. Additionally, the following charts demonstrate the propensity to increase equity is a function of the amount of equity gains, i.e. lower gains yield a higher probability of adding equity, and that refi activity since 2000 has been characterized by a large amount of households lowering their mortgage indebtedness. All three charts should reveal that household’s primary goal with refinancing is to adjust their mix of debt/assets, rather than financing consumption.
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To reiterate, most of the liquefied equity is being used to adjust debt and asset portfolios, as we would expect utility maximizing households to do. What are all the charts from these recent posts telling us about households? |
