Do Rising Home Values Make People Feel Richer?

Economists have often noted that housing prices and household consumption are closely synchronized. When the housing market does well, and home values appreciate, people tend around the same to increase their consumption of other things as well. Of course, this pattern prompts a key question (as our readers swift to parse the distinction between correlation and causation are probably already wondering): Do people buy more stuff because rising home values make them feel wealthier, or do they buy more stuff because consumption and home values are similar but unrelated signs of deeper changes in the economy?

Economists in fact have long theorized that the first scenario may be true, that people experience something called the "wealth effect" when assets that we already own (our homes, or stocks) increase in value. In theory, this makes us wealthier – or at least makes us feel wealthier – and as a result, we feel more comfortable going out and spending money (although the extent of the effect may vary). Based on this theory, economists often look to the housing market for signs about the outlook for other kinds of consumption, too.