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Looking At The Wealth Effect From An Older and Foreign Perspective

About a year and a half ago, I presented a post called The Wealth Effect: Stocks vs. Housing [Matrix] [1] which was simply a definition of the term and linked to the quintessential 2001 paper Comparing Wealth Effects: The stock market versus the housing market [pdf] [2]. Here’s a 2004 Housing Wealth Effect study by Harvard’s JCHS [pdf] [3].

Wealth Effect Defined [Wikipedia] [4]: In economics, the wealth effect is an increase in spending that accompanies an increase in wealth (in absolute terms), or merely a perceived increase in wealth (in relative terms).

The validity of the wealth effect, was further validated in a recent paper presented at the Federal Reserve Bank of San Francisco called: Disentangling the Wealth Effect: Some International Evidence [FRBSF] [5] or download the pdf version [6].

The lessons learned from this study of the wealth effect in foreign markets suggest that the wealth effect doesn’t appear to be some sort of United States fluke, and that an aging population is more influenced by the wealth effect [translation: we have a bubble of aging baby boomers].

A synopsis of the repor

These results suggest that it is important for policymakers to keep an eye on housing market developments separately from financial markets. If it is true that the housing wealth effect dominates the financial wealth effect, at least in some countries, then the effects of a softening in the housing market in a number of industrialized countries could have a more dramatic impact than the historically large stock market declines that began in 2000. Additionally, if the wealth effect is stronger for older households, the demographic changes around the world could make housing wealth effects even more important in the future.