What is the Wealth Effect?

The wealth effect creates the psychological effect that the increase in asset values has a direct impact on consumer spending. This states that consumer confidence automatically improves when the value of assets rises. And this confidence results in more spending, and fewer savings by customers. This approach will take place no matter if the income rises or falls.

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How does the Wealth Effect Work?

Besides the correlation between consumer spending and wealth effect, organizations also start hiring on an increased level and making capital expenditures in lieu of rising asset prices. Market experts are still trying to find the authenticity of the wealth effect in the stock market. There are experts who are of the view that this effect is more related to correlation rather than causation, stating that an increase in spending levels results in asset appreciation. There is solid evidence proving that increased expenditure results in increasing the value of a property. Supporters of the wealth effect say that if interest rates are less and credit is more easily availed, the consumers will be tempted to buy more. This proves to be true for the housing sector. If interest rates are less, there will be more sales of homes. And as demand exceeds supply in this case, this will ultimately increase the worth of homes.