The wealth effect theory
May 19, 2014
The wealth effect is a theory held by many that if your house price and your stock prices go up, you will feel wealthier and then spend more. This will stimulate the economy with your increased demand, and that will in turn increase other peoples paychecks and they too will go out and spend and that his will benefit the economy as a whole.
This sounds reasonable enough and I, too, think as my stock portfolio gains in value and my house equity increases, that I might go out to dinner more and may splurge on a stereo or two.
The Federal Reserve also believes in this wealth effect and both past Fed Chief Ben Bernanke and current Fed Chief Janet Yellen have mentioned this theory and their desire to boost the underlying markets (stocks and real estate) to cause it.
But recently, many analysts including myself have been questioning this theory as it just doesn't seem to be panning out right now.
The Feds indeed have succeeded in boosting the stock market (which is close to all time highs), and home prices have been climbing steadily since the crash. The stock market has climbed by an eye-popping 17 percent or so in 2013 and the Case-Shiller home price index shows a 9.1 percent increase, similar to increases during the real estate bubble. Apparently, their attempt at boosting these particular markets by Quantitative Easing (QE) is working.
But although the stock and housing markets have climbed significantly, this has not translated into any significant increase in consumer spending.
Compared to the last decade and half or so, consumption spending is back at about the same level it was during the crisis years of 2008 and 2009; 2013 spending shows a paltry 1 percent or so annual change.
It begs the question: Does the wealth effect really exist, and if so, how much effect does it really have?
Since current spending statistics are not showing an absolute correlation between rising markets and increased spending, perhaps a re-evaluation of the wealth effect is needed before we base a global monetary policy on this belief.
If rising values of these two assets have not encouraged people to spend more, then the feds' stimulus and QE programs are doing little to improve the economy and are really only helping those who own stocks and homes and that is a very small percentage of the population.
What is not disputed, however, is that QE has substantially improved the balance sheets of Wall Street and the banking sector. This is turn has allowed the 1 percent to grow even wealthier as is evident by statistics showing the number of "high net worth individuals" climbing by 10 percent in 2012, taking the total of high net worth individuals worldwide to about 12 million people. (Figures from the Royal Bank of Canada and consultancy Capgemini)
Between them, these 12 million people owned assets worth $46.2 trillion (more than three times the entire annual output from the US economy), and a 10% increase from 2011.
Apparently the wealth effect works very well for those folks.
This article expresses the opinions of Marc Cuniberti. Mr. Cuniberti hosts "Money Matters" on KVMR FM 89.5 and 105.1 FM on Thursdays at noon and syndicated on over 30 radio stations throughout the US. His website is http://www.moneymanagementradio.com
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