Definition
The wealth effect is the observed tendency for households to spend more when the value of their assets rises and to spend less when it falls. When stock portfolios climb or home prices appreciate, people feel richer and loosen their wallets even if their actual income has not changed.
It is a behavioral link between asset markets and the broader economy, connecting the financial system to everyday consumption.
Why it matters
How it works
When asset values rise, households perceive a larger cushion of lifetime resources. They feel less need to save out of current income and may borrow against the higher value of their homes, so consumption increases. When asset prices fall, the logic reverses: people rebuild savings and cut back, pulling demand down.
The effect tends to be stronger for housing wealth than for stock wealth, partly because home equity is widely held while financial wealth is concentrated. That distributional pattern means the same market move can have very different aggregate effects depending on whose assets changed in value.