Revision:Wealth Effect - Asset prices, debt burden and windfall gains

  • Rising Asset Prices – Positive Wealth Effect: raises consumer confidence, and real wealth increases: can sell equities, or borrow on the strength of their prices; re-mortgage houses.
  • Debt Burden: e.g. early 1990s – many with properties worth less than outstanding mortgage. So have to save harder to reduce debt burden. (also depresses consumer confidence.)
  • Windfall Gains: (1997: £35bn) mergers of building societies and their demutualisation. (Eco theory tells us that an increase in consumers wealth unlikely to lead to a proportionate increase in consumption, with consumer spreading consumption over lifetime – so increase in consumption likely to be relatively small.) – But 1997: larger than expected (1 explanation: liquidity constraints: people unable to borrow on strength of future income – so spend it.)