According to CIBC Economics, falling home prices and eroding real estate wealth are creating a negative wealth effect that is acting as a significant headwind for consumer spending in Canada.
Conventional economic theory holds that changes in household wealth are an important driver of economic activity, influencing household consumption decisions. The permanent income hypothesis, for example, argues that households base their spending decisions on their average long-term income rather than their current income. As a result, changes in wealth that permanently alter households’ financial resources are expected to affect consumption decisions.
While stock market valuations have continued to rise, home prices across much of Canada have generally declined. Given that real estate represents a much larger share of household wealth for most Canadians than financial assets, CIBC argues that the recent housing market correction has created a negative wealth effect. This has weighed on consumer activity, particularly in areas such as renovations and discretionary spending, even as gains in equity markets have boosted other forms of household wealth.
CIBC draws on a recent study from the Federal Reserve Board of Governors to estimate the marginal propensity to consume (MPC) out of real estate wealth. That study found an MPC of approximately 5 per cent, meaning households increased consumption by about five cents for every dollar increase in housing wealth.
How much weight should be placed on this estimate? A 2020 study by JPMorgan Chase examining housing and wealth effects in the U.S. found that the marginal propensity to consume out of rising housing wealth was close to zero and statistically insignificant between 2012 and 2018. Even among households with greater access to liquidity, the relationship was close to zero.
The authors concluded that, following the financial crisis, a larger share of home equity had become concentrated among older and less credit-constrained homeowners. At the same time, tighter lending standards limited access to credit among more financially constrained households, reducing the extent to which rising home values translated into increased spending.
In 2023, OSFI implemented rule changes around home equity lines of credit (HELOC). The revolving, interest-only portion of a HELOC was capped at a maximum 65 per cent loan-to-value (LTV) of a property’s value. While borrowing against home equity can reach up to 80 per cent LTV when combined with a traditional mortgage, any borrowing between the 65 per cent and 80 per cent thresholds must be structured as an amortizing segment, requiring regular principal and interest payments rather than revolving debt.
OSFI explicitly required these structural changes to take effect at a borrower’s scheduled mortgage renewal date, rather than during the mortgage term, to prevent sudden increases in minimum monthly payments. As mortgages have renewed since 2023, however, some households have faced tighter borrowing conditions. Combined with a housing market that has fallen from its 2022 peak – when national home prices were up more than 20 per cent from the previous year – it is reasonable to conclude that the positive wealth effect from housing has weakened and may have already been weighing on consumption for some time.
If we accept BMO’s view that “Canada’s housing market is stabilizing, and we’ve probably found the floor for this long cycle,” then the timing of CIBC’s argument may be backward. The underlying thesis is sound: weaker housing wealth effects have weighed on consumption. However, much of that adjustment likely occurred as home prices declined from their 2022 peak and as tighter lending rules limited access to home equity.
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