How do changes in the level of household wealth affect people's willingness and ability to spend on goods and services?

The wealth effects of rising real asset values on consumer expenditure are difficult to quantify, but important. Trends in consumer wealth are taken into account by the Bank of England when deciding the appropriate level of interest rates for the economy.

HOUSING

When the value of housing and other assets (shares and bonds) is rising faster than income, individuals see a rise in their net worth (the difference between the value of their assets and liabilities). This increases consumer confidence and causes an upward shift in the consumption function.

However, if asset prices fall consumers can be left with a net worth problem. That is, they have liabilities or debts that exceed the value of their assets (negative equity). To eliminate this problem consumers have to repay debts by saving.

Housing is perhaps the most important asset owned by the majority of the population. When house prices are rising and activity in the housing market is growing we often see a boost to total consumption. An appreciation in housing values leads to an increase in personal sector wealth and boosts consumer confidence. An increase in the volume of housing transactions is good news for complementary sectors to the housing market including estate agents, furniture retailers, DIY stores and local contractors.

WINDFALL GAINS

As mutual building societies and insurance companies have converted to public companies their members have received share windfalls. If recipients hold onto these shares they experience a rise in their net worth. This could indirectly boost consumption.

Alternatively if they sell the shares, the cash raised can be spent directly on goods and services. The windfall can also be used to pay off existing debts and allow increased spending in the future. 1997 was a record year for Windfall payments - they totalled over £36 billion pounds. Windfalls have continued through 1998 and 1999 although not on the same scale.

Rising house prices and growing consumer confidence arising from an increase in personal sector wealth are two reasons why the annual growth of consumer spending accelerated during 1999. This is shown in the chart above. The pick-up in household demand was cited by the Bank of England when they started to raise interest rates in September 1999.