The 1970s brought dramatic changes in the size and composition of US household sector wealth. Figure 1 showsthat aggregate household net worth as a fraction of GDP fell by 25% during the 1970s, before recovering again toits late 1960svalue. Figure 2 shows that the aggregate household portfolio sawa 20% shift away from equity and into real estate during the 1970s.
This portfolio adjustment was largely driven by negative comovement of asset prices—house prices rose while equity prices fell, as shown in Figure 3. Compared to the big swings in the major real asset positions, households' net position in nominal credit instruments was relatively stable. As documented below, the stability of net positions masks substantial increases in gross borrowing and lending within the household sector.
This paper develops an asset pricing model with heterogeneous agents and incomplete markets to study the 1970s. The key elements of the model are that households differ by age and wealth and that all credit is nominal, so that inflation matters for bond returns and the cost of borrowing. Our empirical strategy is based on the idea that micro data on household characteristics can be used to directly parametrize household sector asset demand.
In particular, the first step of our analysis is to estimate, for each trading period, (i) the distribution of income and initial asset endowments across households and (ii) household expectations about future prices and income. We then determine optimal household policies given endowments and expectations. Equilibrium prices equate household asset demand to the supply of assets provided by other sectors. We use this framework to evaluate different candidate explanations for the price and portfolio movements in Figures 1-3.
