Wealth effect on consumption and consumption recovery outlook ( Korea )
The wealth effect of rising asset prices (housing prices, stock prices, etc.) inducing consumption growth has increased substantially following the 1997 financial crisis, but it is found that the wealth effect is weakening again, dampening expectations for any significant recovery in consumption.
It will be interesting to see how the recent movements in property and stock prices affect the Korean economy. There are those expecting the rise in property and stock prices to add some bounce to consumption. And there are those concerned that the soon-to-be-released real estate policies will result in a big drop in real estate prices and stamp any sign of recovery in domestic demand.
We will examine to what degree the change in asset prices affected private consumption in the past to help better predict the outlook for the Korean economy.
WEALTH EFFECT APPEARS IN 1992
Before 1992, the relationship between housing prices and private consumption, and stock prices and private consumption was that they had moved in different directions to each other. But, after 1992, they generally moved in the same direction and this indicates that the wealth effect appeared around 1992. As the adverse effects of the boom in speculative real estate investment activity and the 2 million housing unit campaign subsided, the wealth effect of housing prices slowly grew. Meanwhile, capital market liberalization had led to significant improvements in Korea’s stock market, both quantitatively and qualitatively. As a consequence, the ratio of stocks owned to total assets among Korean households greatly increased.
More recently, the relationship between asset prices and consumption appears to be undergoing changes unseen before. Noticeably, the time lag between the low of the consumption growth rate and the low of the housing sales price has increased from ± 1~2 quarters in the past to more than 4 quarters. The increase rate of private consumption is gradually moving upward after hitting the bottom of –2.0% in the third to fourth quarter period of 2003. But the housing sales price increase rate bottomed a year later in the fourth quarter of 2004. Despite the big jump in the composite stock price index this year, the increase rate of private consumption has been quite low compared to the past. These trends suggest that the wealth effect on consumption is weakening. For a clearer picture of wealth effect, econometric models are applied.
HOUSING PRICE EFFECT 10 TIMES GREATER
The data from the first quarter of 1986 to the second quarter of 2005 has been applied to a time-varying parameter model and an OLS model. And the results are as follows.
First, we found that housing prices have a greater wealth effect than stock prices. According to our OLS model, when housing and stock prices increases by 1%, private consumption will expand by 0.17%p and 0.03%p, respectively, showing that housing prices have an effect about 6 times greater than that of stock prices. The similar results were found by the time-varying parameter model. As of the second quarter of 2005, private consumption would have increased by 0.11%p and 0.011%p if housing and stock prices were to rise by 1%, respectively, and so the wealth effect of housing price is about 10 times greater than that of stock price. These results, showing housing prices with substantially larger effect than stock prices, seem to be a reflection of the fact that about 80% of all assets owned by Korean households consists of tangible assets.
WEALTH EFFECT RISES AFTER THE FINANCIAL CRISIS
Second, wealth effect on consumption has increased considerably during the post-crisis years. It was estimated that the response (elasticity) of consumption to the change in asset prices grew from 0.07%p (housing price) and 0.001%p (stock price) during the pre-crisis years to 0.15%p (housing price) and 0.011%p (stock price) during the post-crisis years.
The wealth effect of housing price on consumption increased due to the increase in the rate of home ownership. The census data indicates that the home ownership rate climbed up from 49.9% in 1990 to 53.3% in 1995, to 54.2% in 2000. Also, the National Statistical Office’s sample survey shows that the home ownership rate increased from 58.9% in 2001 to 62.9% in 2004.
The post-crisis years have also seen an increase in the effect of financial asset price on consumption. This is believed to have been induced by the expansion in the size of the stock market, and the increase in the number of households making direct and indirect investments in stocks and beneficiary certificates, for example.
RECENT WEAKENING IN WEALTH EFFECT
A third finding from the econometric models was that wealth effect is weakening more towards the recent years. In the post-crisis period, the wealth effect of a 1% increase in housing price led to a 0.18% increase in consumption in 2001, but the figure dropped to 0.11% in the second quarter of 2005. The wealth effect of housing price has begun to fall since 2002, as household debt has increased to the extent of having to deal with household insolvency. Hence, despite the sharp slowdown in the increase rate of household borrowing since 2003, it has taken more time than anticipated to restructure the excessive household debt and this dramatically lowered the consumption capacity of Korean households irrespective of the rise in the value of their homes.
The wealth effect of stock prices on consumption has also waned. In the fourth quarter of 2002, a 1% in stock prices would generate 0.014% growth in consumption, but the effect weakened to 0.11% in the second quarter of this year. The ratio of foreign investors in Korea’s main bourse and KOSDAQ has steadily increased, while the market value of stocks owned by domestic investors has declined from 68% (KOSPI, 64.3%; KOSDAQ, 89.4%) in 2002 to 60.5% (KOSPI, 58.2%; KOSDAQ, 86.4%) in the second quarter of this year. The increase in the ratio of investment by foreigners in Korean stock markets erodes away the wealth effect of stock price gains on domestic consumption.
Together, housing and stock prices, generated a wealth effect of 0.20% in 2000, but this has plunged to 0.12% during the second quarter of 2005.
GRADUAL CONSUMPTION RECOVERY LIKELY
In Korea the wealth effect of such asset prices as housing and stock on consumption has increased considerably compared to the pre-crisis years, but this analysis has found that such wealth effect has been decreasing in recent years, making it difficult to expect any significant improvement in consumption.
Of course, it is more desirable that consumption recovery is induced by sufficient purchasing power of individual households if we are to achieve a more stable and sustainable consumption growth.
A slow recovery in consumption is projected for the second half of this year. Although the economic growth rate reached 3.0% in the first half, the GNI only grew 0.4% so there is very little to support consumption. Moreover, the Korean economy’s structural issues of income polarization and household debt restructuring will continue to hinder consumption recovery. Except, the recent strength in stock prices indicates that the domestic stock market has factored in the expectations for economic rebound and this will offer some help stimulate consumption.
by LGERI < Link >
It will be interesting to see how the recent movements in property and stock prices affect the Korean economy. There are those expecting the rise in property and stock prices to add some bounce to consumption. And there are those concerned that the soon-to-be-released real estate policies will result in a big drop in real estate prices and stamp any sign of recovery in domestic demand.
We will examine to what degree the change in asset prices affected private consumption in the past to help better predict the outlook for the Korean economy.
WEALTH EFFECT APPEARS IN 1992
Before 1992, the relationship between housing prices and private consumption, and stock prices and private consumption was that they had moved in different directions to each other. But, after 1992, they generally moved in the same direction and this indicates that the wealth effect appeared around 1992. As the adverse effects of the boom in speculative real estate investment activity and the 2 million housing unit campaign subsided, the wealth effect of housing prices slowly grew. Meanwhile, capital market liberalization had led to significant improvements in Korea’s stock market, both quantitatively and qualitatively. As a consequence, the ratio of stocks owned to total assets among Korean households greatly increased.
More recently, the relationship between asset prices and consumption appears to be undergoing changes unseen before. Noticeably, the time lag between the low of the consumption growth rate and the low of the housing sales price has increased from ± 1~2 quarters in the past to more than 4 quarters. The increase rate of private consumption is gradually moving upward after hitting the bottom of –2.0% in the third to fourth quarter period of 2003. But the housing sales price increase rate bottomed a year later in the fourth quarter of 2004. Despite the big jump in the composite stock price index this year, the increase rate of private consumption has been quite low compared to the past. These trends suggest that the wealth effect on consumption is weakening. For a clearer picture of wealth effect, econometric models are applied.
HOUSING PRICE EFFECT 10 TIMES GREATER
The data from the first quarter of 1986 to the second quarter of 2005 has been applied to a time-varying parameter model and an OLS model. And the results are as follows.
First, we found that housing prices have a greater wealth effect than stock prices. According to our OLS model, when housing and stock prices increases by 1%, private consumption will expand by 0.17%p and 0.03%p, respectively, showing that housing prices have an effect about 6 times greater than that of stock prices. The similar results were found by the time-varying parameter model. As of the second quarter of 2005, private consumption would have increased by 0.11%p and 0.011%p if housing and stock prices were to rise by 1%, respectively, and so the wealth effect of housing price is about 10 times greater than that of stock price. These results, showing housing prices with substantially larger effect than stock prices, seem to be a reflection of the fact that about 80% of all assets owned by Korean households consists of tangible assets.
WEALTH EFFECT RISES AFTER THE FINANCIAL CRISIS
Second, wealth effect on consumption has increased considerably during the post-crisis years. It was estimated that the response (elasticity) of consumption to the change in asset prices grew from 0.07%p (housing price) and 0.001%p (stock price) during the pre-crisis years to 0.15%p (housing price) and 0.011%p (stock price) during the post-crisis years.
The wealth effect of housing price on consumption increased due to the increase in the rate of home ownership. The census data indicates that the home ownership rate climbed up from 49.9% in 1990 to 53.3% in 1995, to 54.2% in 2000. Also, the National Statistical Office’s sample survey shows that the home ownership rate increased from 58.9% in 2001 to 62.9% in 2004.
The post-crisis years have also seen an increase in the effect of financial asset price on consumption. This is believed to have been induced by the expansion in the size of the stock market, and the increase in the number of households making direct and indirect investments in stocks and beneficiary certificates, for example.
RECENT WEAKENING IN WEALTH EFFECT
A third finding from the econometric models was that wealth effect is weakening more towards the recent years. In the post-crisis period, the wealth effect of a 1% increase in housing price led to a 0.18% increase in consumption in 2001, but the figure dropped to 0.11% in the second quarter of 2005. The wealth effect of housing price has begun to fall since 2002, as household debt has increased to the extent of having to deal with household insolvency. Hence, despite the sharp slowdown in the increase rate of household borrowing since 2003, it has taken more time than anticipated to restructure the excessive household debt and this dramatically lowered the consumption capacity of Korean households irrespective of the rise in the value of their homes.
The wealth effect of stock prices on consumption has also waned. In the fourth quarter of 2002, a 1% in stock prices would generate 0.014% growth in consumption, but the effect weakened to 0.11% in the second quarter of this year. The ratio of foreign investors in Korea’s main bourse and KOSDAQ has steadily increased, while the market value of stocks owned by domestic investors has declined from 68% (KOSPI, 64.3%; KOSDAQ, 89.4%) in 2002 to 60.5% (KOSPI, 58.2%; KOSDAQ, 86.4%) in the second quarter of this year. The increase in the ratio of investment by foreigners in Korean stock markets erodes away the wealth effect of stock price gains on domestic consumption.
Together, housing and stock prices, generated a wealth effect of 0.20% in 2000, but this has plunged to 0.12% during the second quarter of 2005.
GRADUAL CONSUMPTION RECOVERY LIKELY
In Korea the wealth effect of such asset prices as housing and stock on consumption has increased considerably compared to the pre-crisis years, but this analysis has found that such wealth effect has been decreasing in recent years, making it difficult to expect any significant improvement in consumption.
Of course, it is more desirable that consumption recovery is induced by sufficient purchasing power of individual households if we are to achieve a more stable and sustainable consumption growth.
A slow recovery in consumption is projected for the second half of this year. Although the economic growth rate reached 3.0% in the first half, the GNI only grew 0.4% so there is very little to support consumption. Moreover, the Korean economy’s structural issues of income polarization and household debt restructuring will continue to hinder consumption recovery. Except, the recent strength in stock prices indicates that the domestic stock market has factored in the expectations for economic rebound and this will offer some help stimulate consumption.
by LGERI < Link >
posted by Joa at
Monday, September 05, 2005
