The wealth effect: How perceived prosperity drives spending—and how to stay in control
Subscribe to enjoy similar stories. You’re standing in the elevator lobby of your 14th-floor apartment, scrolling through e-commerce deals on your phone, though you have no intention of making a purchase. A neighbour enters, and after the usual pleasantries, mentions the price at which an apartment in the building recently sold.
You’re pleasantly surprised to learn that the price has increased significantly compared to what you paid seven years ago. As you enter your apartment, you unlock your phone again to find the app still showing the discount on the latest model of your 18-month-old phone. Without much thought, you click ‘Buy Now.’ Read this | Navigating - and optimising - the three phases of wealth creation What’s at play here is the “wealth effect," a concept that describes how an increase in perceived wealth—whether from rising home values or a surging stock portfolio—encourages more spending, even when actual income remains unchanged.
First explored in a 2001 paper by Karl Case, John Quigley, and Robert Shiller, the wealth effect was revisited in 2013, showing that housing wealth significantly influences household consumption. A recent Visa study in the US found that for every dollar increase in household wealth, spending rose by $0.34—$0.24 from securities and $0.20 from housing. The reverse holds true as well: a decline in perceived wealth often leads to more cautious spending.
The wealth effect isn’t based on actual cash but is a psychological shift, much like the feeling of walking on a thick carpet that feels softer than a bare floor. It creates a cushion of comfort that encourages spending, even if that cushion is illusory. Human psychology plays a central role here.
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