The variability of the housing market has a direct impact on the economy. When the prices of houses rise, this encourages spending as people’s assets are worth more. With increased spending, more money is being pumped into the economy leading to economic growth. This refers to the positive wealth effect.
The positive wealth effect also suggests that in such scenarios these homeowners are able to release some equity by borrowing more against the increased value of their property.
On the flip side, when house prices are falling, the economy is showing us a negative wealth effect. When house prices fall, people tend to cut their spending as consumer confidence is affected negatively. As a result, the economic growth shrinks and may eventually lead to a recession. Falling house prices cause more people to be trapped in negative equity (a situation where your house is worth less than an outstanding mortgage). This causes a fall in spending and precludes any opportunity for equity withdrawal. Additionally, falling house prices have a negative impact on the construction of new houses.