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of the services supplied by it. A fall in house prices reduces the value of an asset,
but also reduces the cost of buying the stream of housing services that people were
planning to purchase by exactly the same amount.
It is possible to have a nonzero effect on aggregate expenditure on other goods
(when other prices remain unchanged), even without financial frictions, owing to
redistribution of wealth between households with a net “long” position in housing
and those with net “short” positions, if the average marginal propensities to consume
out of wealth are different between the two types. Nonetheless, because the positive
and negative wealth effects will largely offset one another, the effect on aggregate
demand is likely to be fairly small relative to the size of the aggregate decrease in
Larger effects are instead possible if one recognizes that the losses resulting
from the collapse of housing prices were disproportionately concentrated in certain
financial institutions which play a role in the allocation of resources that cannot
easily be repla...
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