House Prices and the Wealth Effect Essay Example | Topics and Well Written Essays - 1000 words - 11

House Prices and the Wealth Effect - Essay Example In a typical household, shares account for a relatively smaller proportion of average assets while housing takes the huge proportion. People will rather invest in housing that has moderate rises in price compared to the stock market that has sharp unpredictable prizes. Home values are thus more evenly distributed that financial related wealth that is spread among the rich whose spending has less effect on changing waves. Change in house prices thus presents much higher effect to many people that change in share prices (Case, Quigley, & Shiller 3). However, this is not true across all economies. The influence of financial assets is much greater than that of housing wealth in Britain than in America because of Britain having refined instruments through which money is spent. In America, weakness in wealth effect on consumption was expected to reduce spending but the opposite happened. As more Americans became poor from the fallen share prices, spending grew considerably hence helping America avoids getting into recession. Housing prices instead went higher thus squaring out the effect of fallen stock prices. However, empty homes and increased unemployment have indicated that consumer spending is driven by real earnings that influence projections of earnings from stocks, property, and bonds. Thus fallen asset values that cause investors to spend less and the rest are put into savings (The Economist, â€Å"A housing slump helped† 1). For example in the US in 2004, an increase in wealth by $1 caused an increase in spending between 1 and 7 cents. This translated to 0.0375 wealth effect for a model that assumed equal effect between housing and financial assets. The policymakers consider housing wealth as having a similar effect as financial wealth in microeconomics sense. However, some people have already established fault in such conclusion. They argue that increase in the price of property increase cost of housing.