of - capital effect is likely to be at work when stock prices rise or fall significantly. karen e dynan and dean m maki, “ does stock market wealth matter for consumption? ” finance and economics discussion series paper 2001 - 23 ( board of governors of the federal reserve system, may 2001 ). dean m maki and michael g palumbo, “ disentangling the wealth effect : a cohort analysis of household saving in the 1990s, ” finance and economics discussion series paper 2001 - 21 ( board of governors of the federal reserve system, april 2001 ). jason g cummins, kevin a hassett, and r glenn hubbard, “ a reconsideration of investment behavior using tax reforms as natural experiments, ” brookings papers on economic activity, 2 : 1994, pp 1 - 59 ; and stacey tevlin and karl whelan, “ explaining the investment boom of the 1990s, ” finance and economics discussion series paper 2000 - 11 ( board of governors of the federal reserve system, february 2000 ) and journal of money, credit and banking ( forthcoming ). jason g cummins, kevin a hassett, and stephen d oliner, “ investment behavior, observable expectations, and internal funds, ” finance and economics discussion series paper 1999 - 27 ( board of governors of the federal reserve system, may 1999 ). two unresolved issues regarding the link between wealth and consumption let me return to the relationship between household wealth and consumption. although the current body of empirical literature on this topic sends a rather clear message, it does not answer all the questions. let me highlight two unresolved issues that i find particularly intriguing and that deserve further study. the first issue pertains to the underlying forces causing the value of the stock market to change. the value of equities can change for two basic reasons : because market participants adopt a new view of future profits, or because market participants apply a different set of discount factors to those expectations of future profits. the discount factors incorporate both risk - free interest rates and equity premia, but i will refer to the discount factors simply as interest rates. consider the effect of an increase in expected profits, say from a spurt in productivity. to the extent that higher expected profits reflect higher expected future output and income - - and not just a redistribution of income from labor to capital - - both economic intuition and formal models suggest that desired household spending should increase, all else equal. consumers foresee their future

in the price of my house reflects a change in the housing services that the house is expected to provide, perhaps because individuals have come to think that houses will depreciate more slowly in the future than we had believed. in this situation, a higher house price would be accompanied by an increase in my real consumption of housing services over time but - - as long as i stayed in the same house - - by no change in my consumption of other goods and services. a second complicating factor is that many homeowners do not intend to live in their current houses forever. many expect to move to smaller houses, condominiums, or retirement communities as they get older. these individuals, who plan to “ downsize ” their housing over time, are truly better off when house prices increase, and any standard theory would predict that they will increase their consumption. at the same time, many individuals who do not currently own homes - - or who own small homes - - likely plan to purchase homes and increase their consumption of housing services in the future. these “ upsizers ” are worse off when house prices increase, and they will reduce their consumption of non - housing goods and services. the effect of changes in house prices on desired aggregate consumption depends on the relative number of individuals in these two groups and their marginal propensities to consume out of housing wealth. a third factor, which chairman greenspan has recently emphasized, is the effect of realizing capital gains in housing by selling one ’ s house or by borrowing through a home equity loan. accumulated home equity is not itself a liquid asset. in addition, its value is somewhat uncertain : although general trends in real estate prices can be easily observed, nobody receives a statement in the mail saying how much his or her home is worth, and nobody can look up the value of his or her home in the newspaper. selling a house, or getting one ’ s house appraised and taking out a home equity loan, converts this illiquid home equity of uncertain value into liquid funds with known value. recent experience and the response of monetary policy let me now turn to the recent u. s. experience, including the macroeconomic consequences of movements in asset prices since the mid - 1990s and the response of monetary policymakers. as you know, the second half of the 1990s saw a record - breaking run - up in equity values in the united states. in early 1995, the net worth of u. s. households was about 4