Moving Wealth Effects

June 17th, 2013 at 9:45 am

The wealth effect is what economists call the changes to income and spending that occur when asset values go up or down.  In this regard, a key factor behind both the recession and recovery was the sharp decline and now the increase in home values.  However, in a dynamic I’ve written about before, these values are not fixed.  

Some have argued the wealth effect is asymmetrical–larger going up than coming down, implying a larger boost to growth (and/or a growth bubble) in periods of asset appreciation than a drag on growth when asset values tank.  But Samuelson cites a different effect this AM: a weaker wealth effect this time around.

He cites economist Mark Zandi as suggesting that the wealth effect from quick-rising home values during the housing bubble might have been as high as eight cents on the dollar (that’s quite a high estimate) but now is probably only between 2-3 cents.

Like I said, these elasticities change with conditions and sentiments, and of the various factors Samuelson runs through, I suspect loss aversion is the biggest.  We may have short economic memories, but I’m sure many of us remember how much our home values fell during the bust, even if we’d paid off our mortgage or had no intention of selling.

It’s as if you were riding a bike too fast, lost control, crashed and badly scraped yourself up.  Even once you’re back up and running, you’re like to pedal pretty slowly for awhile.

Update: Dean Baker has an interesting take on this here.  He doesn’t address the changing wealth effect that I focus on above, but he shows that given the decline in the real, underlying amount of housing and stock market wealth, we wouldn’t expect consumers to be spending more than they are.

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5 comments in reply to "Moving Wealth Effects"


  1. Kevin Rica says:

    I hate to be a grump (no, not really), but the only real wealth effect of housing is paying down your mortgage.

    Because if in Year 0, you lay out $200K to buy the house at 1441 Peachpit Lane, and in Year 5, the 1441 Peachpit Lane is worth $400K, it’s now worth exactly enough to buy the house at 1441 Peachpit Lane. Your wealth has not changed.


    • David C says:

      But if you sell your house, you don’t have to buy another one. You can rent, you can move in with your mother, you can buy a sailboat and sail to Tahiti. In any of these cases, the increase in house price has put $200,000 in your pocket that you didn’t have before.

      $200,000 would last a long time, living on a sailboat.


      • Kevin Rica says:

        David,

        You make a valid point. Those are good options except for moving in with your mother (especially from your mother’s perspective).

        If you own and then downsize if you don’t need the space (move into a rest home or coffin), you are the beneficiary of a TRANSFER of wealth.

        So if Peter buys a house for $200K and sells it to Paul for $400K, then what Peter gains in wealth (ability to purchase goods and services) is matched by Paul’s decreased ability to purchase goods other than the house. On an aggregate level, no real wealth has been created. Any increase in Peter’s wealth is matched by by Paul’s loss.

        A lot of the wealth effect that was so evident before the crisis was due to a deterioration of prudential lending standards, idiots making home equity loans to morons who were using their homes as ATMs.

        On the other hand (I love HST, but obviously he would have had mixed feelings about me), had housing prices remained stable, but a second, identical $200K house been built, that would be a real increase in aggregate wealth.


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