Stock prices and house prices in California: new evidence of a wealth effect?

A crucial macroeconomic question facing the US economy is whether the value of the stock market has implications for consumption. If it does, it means that any severe downturn in the market could lead to a contraction of consumption, and therefore a contraction in the overall economy. The issue is one on which academics and the financial community seem to disagree. Rigorous academic works (Fama, 1981; Fisher and Merton, 1984; Barro, 1990; Poterba and Samwick, 1995), have generally found that the wealth effect on consumption is quite small, while research reports from financial service companies generally assert that the effect is real and important. This paper is different from its predecessors in that it focuses on one particular market: the San Francisco Bay area housing market. It will argue that this market is a prime candidate for a wealth effect to be large, and it will compare it to another market (Southern California) where we would expect the effect to be considerably smaller. We find that under circumscribed conditions, it is possible to 1 find a strong wealth effect in a particular market .