Economics focus: Home truths

"A housing slump helped cause the credit crisis. But its effect on spending may have been exaggeratedFALLING house prices have been at the heart of the rich world’s economic troubles in the past year. They led to the surge in defaults on American subprime mortgages that poisoned the market for asset-backed securities and drove up inter-bank rates. Mortgage-related losses have made international banks wary of lending to even creditworthy borrowers. The drying-up of credit has meant fewer buyers for new homes, leading to construction busts in America, Spain and Ireland. Now even countries unaffected by the global housing boom, such as Germany and Japan, are suffering from weaker export demand.In America the tangible impact of the housing slump is plain to see in the number of empty homes and in rising unemployment. There is greater uncertainty about the indirect effects of falling house prices, including the extent to which consumer spending will be held back by the “wealth effect”. Spending is largely driven by how much people earn in real terms today, but it is also affected by expectations about incomes tomorrow. An important part of future incomes is tied up in the assets—stocks, bonds, property—where household wealth is stored. When asset values fall, those who own them are poorer, hence they spend less and save more. When wealth increases, they spend more. ..." (2008-8-7)

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