Homeowners’ lousy memories could be damaging the economy. That's the key finding of a report out this month from the Central Bank of Ireland, which asked Irish homeowners to report how much they paid for their houses, and then compared their responses to the actual prices as recorded in bank records.
The results are surprising: On average, Irish homeowners underestimated their purchase price by 70,000 euros (roughly $90,000 in 2012 dollars), or nearly 20 percent of the actual home value. Take a look at the distributions below and note that they tend leftward from the zero line, indicating an underestimation of the actual price. Perhaps most shocking is that, looking at the percentage breakdown, a not so trivial amount of survey respondents underestimated their purchase price by nearly 100 percent!
I asked one of the study co-authors, Kieran McQuinn, about this. He responded:
It is the case that in certain extreme cases the error made in recalling the price exceeded the actual price of the property. It must be recalled that for the period in question house prices were rising very sharply and that at the upper end of the market prices were quite sharply [rising] year-on-year. Therefore, it is not totally inconceivable that such an error could be made.
The survey was conducted in 2012, meaning that many respondents had bought their homes during Ireland's housing bubble and subsequent crash in 2007. The volatility of the housing market during that time likely contributed to some respondents' difficulties in recalling their true purchase price. McQuinn told the Irish Times that another possible reason for the discrepancy is that homeowners were "trying to reassure themselves that their losses as a result of the property crash are not as great as they are."
Regardless of the underlying cause, homeowners' wildly inaccurate assessments of their purchase prices have real-world implications. Economists have noted a "housing wealth effect" -- an increase in consumer spending that tends to accompany a perceived increase in housing wealth. If Irish homeowners understate their home's actual value, it may cause them to spend less --up to a whopping 70 percent less, according to McCarthy and McQuinn's calculations. This would have obvious negative consequences for the Irish economy.
I asked the authors whether the same kind of error in recall might be happening in the United States. While there hasn't been a similar study of American homeowners, McQuinn said the following:
In the case of the U.S., it is worth noting that certain parts of the U.S. market experienced similar type fluctuations in prices to the Irish case, so that there is a good possibility that this type of recall error would be in evidence in the U.S. market.
The U.S. housing market has experienced a wild ride similar to Ireland's, so perhaps American homeowners would also underestimate when recalling their purchase price. If that's true, and if it's affecting consumer spending, it could be one factor behind our lackluster recovery from the Great Recession.