Household leverage, re-leveraging and spending behaviour

Two factors make movements in house prices especially important for consumption spending and the wider economy. The first is that it represents a significant proportion of households' wealth.

According to the ONS, in the UK, property accounts for three quarters of households' aggregate marketable net wealth. The second factor is leverage. The vast majority of UK households purchase their first home with substantial credit, leading to a large difference between households gross and net asset positions. Under standard mortgage contracts households' liabilities do not change as house prices rises and fall, meaning that for leveraged households, price movements can lead to significant changes in a households' net housing wealth. As a result, leverage can magnify the effects of economic shocks on households' overall balance sheets, with potentially important implications for their willingness to spend as well as their access to credit.

In the proposed research, we will provide new empirical evidence on the extent to which UK households adjusted their leverage over periods of rising and falling house prices, as well as on how leverage affects consumer spending decisions in the response to changes in their housing wealth. We will also examine how consumers may have acted over the period of the recession had different macro-prudential policies been introduced pre-crisis. Our empirical strategy requires both detailed and comprehensive spending micro-data and data on household balance sheets. Since no single, large dataset containing this information exists in the UK, we will combine available information contained in the ESRC's secondary dataset Understanding Society/the British Household Panel Survey and the ONS's Living Costs and Food Survey using two-sample methods.

Our research will proceed through three stages.

In the first stage, we will investigate the degree to which households' may have re-leveraged (de-leveraged) in response to house price increases (falls). When house prices rise, household loan to value ratios will mechanically fall, reducing the risk and return on household portfolios. Households may either accept this reduction in their leverage, or they may act to counteract it by actively increasing their borrowing. We will empirically examine household responses to investigate the extent of active re-leveraging in the UK.

In the second stage, we will not only investigate whether more leveraged households increase their spending by more in response to house price increases, but also how they adjust their spending. This latter question requires use of the Living Costs and Food Survey. This latter question is important because, as we discuss in our Case for Support, it is important for testing various hypotheses around the mechanisms through which leverage may amplify the effect of house price changes. Our approach will allow for the fact that leverage is a choice variable that is potentially correlated with other confounding variables.

In the third stage of our research we will apply our findings to make constructive recommendations about government policy, paying particular attention to the design of macro-prudential policies aimed at preventing excessive leverage growth among households. To do this we will not only draw on our empirical findings from the work set out above, but also examine the response of consumers to specific macro-prudential policies through a dynamic structural model of consumer behaviour. The construction of this model would allow us to simulate the responses of consumers to different policy regimes and directly quantify their potential impact. This would include for example an assessment of the relative impacts of restrictions on loan-to-value and loan-to-income ratios on consumer spending and welfare. This final part of the project would draw on some of the investigators' deep experience in the programming, estimation and calibration of such models.

The proposed research is in a highly policy-relevant area and thus has the potential to have a lot of impact. We believe our research findings will be particularly relevant for those policy makers and analysts concerned with:

1) The role of housing and debt in the macroeconomy,
2) The causes of house price booms,
3) Macroprudential regulation and other policies aimed at saving and borrowing.

We plan to maximise our impact in several ways, drawing on the extensive experience that IFS, Essex, and Cambridge have in this area.

Our findings will initially be written up in the form of two Working Papers before submission to appropriate high-quality journals. We will disseminate these to fellow academics using standard channels such as direct contacts, conference presentations and by publishing these papers in the working paper series of our respective organisations. Importantly however we would also seek to distribute our findings among non-academic beneficiaries, journalists and the public. To this end our academic outputs will be accompanied by non-technical summaries of our main findings that will be made available on the websites of the IFS, the University of Essex and the University of Cambridge. In the past, we have also found short blog posts or IFS "Observations" are particularly effective means of dissemination and we would aim to produce these as the project progresses (particularly if our work is relevant for topics of current media discussion). Our final results will also be press-released using the IFS's exhaustive list of press contacts, as well as by exploiting our respective organisations' large and growing presence on social media platforms such as Twitter, email bulletins and so on.

In addition we will set up a Project Advisory Group. This will meet multiple times over the course of the project, assisting us with planning, feedback and dissemination. The group will include representatives of the Bank of England, the Financial Conduct Authority and other interested parties. We will also recruit a number of other experts with extensive experience of research and policy in this area. This would ensure we will be in direct communication with policymakers and other academics from the outset of the project.

Finally, towards the end of the project, we will hold an event at IFS to publicize the results to non-academics. We would use the extensive contacts of the project investigators, and of our organizations more generally, to ensure that relevant policy makers are invited to this event. We would also advertise the launch event widely in order to attract individuals from other organisations. We would expect around 60 to 100 attendees at such a conference.