Discussion paper
DP20766 Why Net Worth is the Wrong Concept for Explaining Consumption: Evidence from Italy
Most econometric policy models at central banks use a ‘representative agent’ aggregate consumption function in which net worth (summing all household assets less debt) proxies for balance sheet effects and borrowing and liquidity constraints are absent. This conventional formulation is inconsistent with heterogeneous agent behaviour under uncertainty in incomplete markets. Using aggregate quarterly Italian data from 1980-2019, our more general model rejects the above formulation. We instead find different marginal propensities to consume out of liquid and less liquid wealth components. Moreover, rising housing prices have a dual effect on consumption, increasing housing wealth for owners, and worsening housing affordability.
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