A wealth effect occurs when there is an increase in household wealth. Wealth is a store of value and for the majority of households in the UK this is the wealth stored in the value of their house however it could also include savings, gold etc.

When household wealth increases it creates a number of positive effects.

1. Consumer confidence increases which causes consumers to reduce savings and spend on consumption. Consumers feel that there is less risk in spending money rather than saving.
2. Households can use their extra wealth as collateral to take out loans. In addition households may be able to withdraw equity from their property.
3. Incomes related to the wealth increases e.g. dividends and rents.

A further benefit for the macroeconomy may also occur if governments choose/are able to tax the increasing wealth e.g. stamp duty and inheritance taxes.

Considerations

1. Increased wealth will not necessarily lead to great increases in consumption, wealth is often a very non liquid asset meaning that it is difficult to turn the wealth into spendable cash.
2. As most household wealth is linked to property prices, individuals that are moving house do not necessarily benefit from the increased value as other houses have similarly increased in value. This is not the case for people downsizing their houses or inheriting.
3. Who is benefitting from the extra wealth? Wealth increases in the lowest income brackets are likely to be spent on consumption whereas wealth increases in the highest income brackets are likely to be further saved.
4. The wealth effect is somewhat at the mercy of cyclical prices. house prices rise and fall. At the time of writing in 2022 there are real concerns that the housing market bubble in the UK is overpriced and at risk of bursting.
5. Causation - Do increases in wealth cause the extra consumption or does the extra consumption cause an increase in wealth?