New vehicle sales in the U.S. fell nearly 40 percent during the last recession, causing significant job losses and unprecedented government interventions in the auto industry. This paper explores two potential explanations for this decline: falling home values and falling households' income expectations. First, we establish that declining home values explain only a small portion of the observed reduction in vehicle sales. Using a county-level panel from the episode, we find: (1) A one-dollar fall in home values reduced new vehicle spending by about 0.9 cents; and (2) Falling home values explain approximately 19 percent of the aggregate vehicle spending decline. Next, examining state-level data from 1997-2016, we find: (3) The short-run responses of vehicle consumption to home value changes are larger in the 2005-2011 period relative to other years, but at longer horizons (e.g. 5 years), the responses are similar across the two sub-periods; and (4) The service flow from vehicles, as measured from miles traveled, responds very little to house price shocks. We also detail the sources of the differences between our findings (1) and (2) from existing research. Second, we establish that declining current and expected future income expectations played an important role in the auto market's collapse. We build a permanent income model augmented to include infrequent, repeated car buying. Our calibrated model matches the pre-recession distribution of auto vintages and exhibits a large vehicle sales decline in response to a moderate decline in expected permanent income. In response to the decline in permanent income, households delay replacing existing vehicles, allowing them smooth the effects of the income shock without significantly adjusting the service flow from their vehicles. Combining our negative results regarding housing wealth with our positive model-based findings, we interpret the auto market collapse as consistent with existing permanent income based approaches to durable goods consumption (e.g., Leahy and Zeira (2005)).
https://doi.org/10.20955/wp.2018.019
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