What Drives Urban Consumption in Mainland China? The Role of Property Price Dynamics

• Author: Yu‐Fu Chen,Aaron Mehrotra,Michael Funke
• Published date: 01 August 2017
• DOI: http://doi.org/10.1111/1468-0106.12078
• Date: 01 August 2017

WHAT DRIVES URBAN CONSUMPTION IN MAINLAND

CHINA? THE ROLE OF PROPERTY PRICE DYNAMICS

YU-FUCHEN*University of Dundee

MICHAEL FUNKE Hamburg University and CESifo Munich

AARON MEHROTRA Bank for International Settlements

Abstract. This paper adds to the literature on wealth effects on consumption by disentangling house

price effects on consumption for mainland China. In a stochastic modelling framework, the riski-

ness, rate of increase and persistence of house price movements have different implications for the

consumption/housing ratio. We exploit the geographical variation in property prices by using a

quarterly city-level panel data set for the period 1998Q1–2009Q4 and rely on a panel error correction

model. Overall, the results suggest a significant long-run impact of property prices on consumption.

They also broadly confirm the predictions from the theoretical model.

1. INTRODUCTION

It is by now common knowledge that the housing bubble was the major, if not

the only, cause of the subprime crisis and worldwide economic and financial

crisis of 2007–2009. Just as the preceding property bubble had created dynamics

that tended to be self-perpetuating, the dynamics of the broader economic crisis

were also self-perpetuating, albeit in the opposite direction. Despite its impor-

tance, mainstream macroeconomics either treats housing as one of many

consumption goods, or ignores the housing market altogether. In contrast,

conventional housing economics research for its part virtually ignores interac-

tions with the macroeconomy.

With property prices soaring in China due to rapid economic growth, rising

family incomes, accommodative monetary policy during the financial crisis and

continued migration to the cities, many economists worry that China risks being

a host to the next great property bubble set to burst. Housing affordability in

some of the larger cities, such as Beijing, Hangzhou, Nanjing, Ningbo, Qingdao

and Shanghai, has also become an increasingly prominent political issue. Being

aware of the risk of derailing the housing market, the Chinese government has

*Address for Correspondence: Economic Studies, University of Dundee, 3 Perth Road, Dundee DD1

4HN, UK. E-mail: y.f.chen@dundee.ac.uk. We thank an anonymous referee and the editor for

helpful comments and suggestions on an earlier draft. All views are those of the authors and do not

necessarily reflect those of the Bank for International Settlements or the Hong Kong Monetary

Authority. We thank participants at the Deutsche Bundesbank Workshop ‘Money, Finance and

Banking in East Asia’, and seminar participants in Helsinki and Hong Kong for helpful comments

on an earlier draft. Also, special thanks for helpful comments and suggestions to participants of the

conference on the restructuring of China’s economy jointly organized by the China Economic

Research Center at Stockholm School of Economics and the China Center for Economic Research

at Peking University (16–17 August 2012) and the 44th Annual Money Macro and Finance Con-

ference in Dublin (6–8 September 2012). Previous drafts of the paper have been published as

HKIMR Working Paper no. 15/2011 and BOFIT Bank of Finland Discussion Paper no. 13/2011.

Any errors are our own.

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doi: 10.1111/1468-0106.12078

© 2016 John Wiley & Sons Australia, Ltd

Pacific Economic Review, 2 : 3 (201 )2 7 pp. –383409

begun to lean against the wind, making an effort in spring 2010 to gradually halt

the climb in house prices.1In particular, downpayment requirements were raised

across the country as a whole. Minimum mortgage interest rates have been

increased, and home purchase restrictions have been set.

Several papers have analysed the impact of housing wealth on consumption.

Most of these studies, however, focus on the Anglo-Saxon or euro area coun-

tries. In contrast, the house price–consumption nexus in Asia is far less

researched than in Europe and the USA due to the paucity of disaggregated

data.2The present paper adds to the literature on house price effects on con-

sumption by disentangling property price effects for mainland China. In a

stochastic modelling framework, the riskiness, speed and persistence of house

price movements have different implications for the consumption/housing ratio.

We apply panel data techniques to a city-level data set for mainland China. The

heterogeneity present in the city-level data allows us to test whether the predic-

tions from the theoretical model hold in the data, in addition to examining

whether there is a significant overall impact of house prices on consumption in

China.

The rest of the paper is organized as follows. Section 2 describes the theoreti-

cal house price–consumption model that is the main tool of our analysis. Section

3 describes the data, outlines the econometric methodology and presents

the empirical results. Section 4 concludes and the data are explained in the

appendices.

2. HOUSING–CONSUMPTION MODEL SETUP

How are property prices and consumption interrelated? To what extent do

house prices influence consumption? Which mechanism underlies the link

between property prices and consumption?3To assess the importance of these

and other factors, we construct a simple model along the lines of the work by

Piazzesi et al. (2007) and Flavin and Nakagawa (2008), which incorporates an

1Some observers argue that China’s inflated property prices are reminiscent of Japan’s real estate

bubble in the latter half of the 1980s, and believe the Chinese authorities, via accommodative

monetary policy and a quasi-fixed exchange rate, are in danger of repeating the mistakes of their

Japanese neighbour. According to the evidence from eight large cities in Wu et al. (2012), housing

markets look rather risky based on the affordability price-to-rent and price-to-income ratio meas-

ures. The upward trajectory in Chinese housing prices, however, does not necessarily represent a

bubble. Structural factors, including favourable demographics, increased urbanization, rapid

income growth and high household saving rates, have underpinned the buoyant demand.

2Ahuja et al. (2010) investigate house price misalignments in China using alternative empirical

approaches. They find a small and insignificant impact of property prices on Chinese consumption.

However, this may be driven by the fact that the authors match city-level data for housing prices

with provincial-level macro variables, whereas our study uses city-level data for both. Another

difference between their study and ours is that the models estimated in Ahuja et al. (2010) are in first

differences, not considering long-run relationships. Koivu (2010) also provides evidence on the

impact of equity and residential property prices on consumption in Mainland China using a

structural vector autoregression, but finds that the link between asset prices and consumption is not

robust. Ciarlone (2011) uses a broader set of emerging market countries to show that both real and

financial wealth positively affect households’ consumption in the long run.

3The terms ‘house prices’ and ‘property prices’ will be used interchangeably in this paper.

Y-F. CHEN ET AL.

© 2016 John Wiley & Sons Australia, Ltd

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