About that “Wealth Effect”: Not so Much…
Economists like to say that their discipline is the study of scarcity, or even the science of scarcity. But I’d like to suggest that — acknowledging that it’s a behavioral, social “science” — it’s actually the study of human reaction functions: If X happens, how do people (individually and as groups) react?
But unlike other scientists, rather than studying these reaction functions — human behavior — economists are prone to stating their results as a priori assumptions (and that, absent any solid quantification). You’ll be hard-pressed, for instance, to find Kahnemann and Tversky’s quite detailed empirical numbers on human risk-aversion incorporated into mainstream economic models (even though that research — from psychologists — earned the Nobel Prize in economics).
The wealth effect is a great example of this approach: “If people have more money, they’ll spend more.” Okay, that seems to make sense as an armchair proposition, but how much more, and what’s the likelihood across a heterogenous population?
Which leads me to share the rather eye-popping empirical result that prompts this post, a finding in a Royal Bank of Canada survey, reported by Pedro da Costa:
(Apparently the RBS research is proprietary, as da Costa doesn’t provide a link and I can’t find the study.)
If it’s true that U.S. monetary policy these days is achieving its effect largely or purely through the wealth effect, given these findings it’s not surprising that monetary policy isn’t having the profound effects that one might hope for.
Cross-posted at Asymptosis.
Here’s my reasoning. Wealth is the accumulated excess of income over spending plus the accumulated returns on those excesses.
Whatever wealth effect that may obtain is an income effect in disguise.
Income drives consumption.
http://angrybearblog.strategydemo.com/2012/03/1-spending-as-fraction-of-net-worth-tim.html
Cheers!
JzB
One caveat – these results are self-reporting on a hypothetical. What people tell a pollster they WOULD do and what they ACTUALLY do could be two different things
Great Bernanke quote in your link. He admits that the only thing monetary policy has been able to do is inflate asset prices.
The bottom 20% have zero assets, at best. The next 30%, not much.
It just percolates to the top.
@Jazz: I knew you’d like this. While there’s certainly a group (retirees like me living off investments who are wondering if their money will last till they die) who unequivocably adjust their spending in response to significant wealth moves (S&P up 100%+!), it’s a small part of the population and I think even their adjustments are small relative to income-change-driven adjustments by others.
@Scott F: Yes it’s not a great piece of empirical evidence, but I thought the magnitudes were huge and surprising enough to be worth pointing out.
The three big slices make up 90% of consumers. A reasonable shorthand for those three slices :
46% slice = average stiffs , like you and me
19% slice = those whose incomes rely on selling goods and services to the average stiffs in the 49% slice
25% slice = those who have secure incomes , either via their jobs or their accumulated wealth , such that changes in the macro economy have little effect on their spending. They spend as they please , always have and always will.
The two smaller slices , adding up to the remaining 10% , are probably people on the margins of the 25% slice above , so have some sensitivity to changes in asset values , but don’t represent much of a reservoir of spending capacity for the “wealth effect” to operate through.
Jazz,
It’s not perculating anymore. It just goes direct to the top. That’s the new structure.
It makes sense that people are reluctant to part with wealth unless they are confident they will be able to replace it. That means having a job and being confident they can find another one if they lose the current job. That’s why the only useful stimulus under circumstances like this is direct job creation — and not the traditional make-work that gets withdrawn as soon as the economy starts to recover or a helicopter drop, but several million solid, permanent, well-paid (and non-outsourceable) jobs that add genuine value to the country. A real commitment to modernizing and maintaining the infrastructure — a 30 year project with a significant permanent component — would fit that bill. Tax reductions, not so much.
The “jobless recovery” of the Bush years, combined with some instinctive recognition that the employment level reached in 2007 needed a real estate bubble to happen, has reinforced doubts that income spent will be replaceable.
Urban Legend
if you run on that platform I will vote for you. but don’t let me down.
@Marco:
I like those slices! Is there some criterion/measure by which you specify the cutoffs?
@Daniel: “It’s not perculating anymore.”
Wait, you mean trickle-down isn’t working?? (And: whaddaya mean “anymore”?)
@ Steve
“…Is there some criterion/measure by which you specify the cutoffs?”
Random neurons firing is my only excuse.
It just seems to fit to me. The big slice represents consumers who spend only out of wage income , and spend essentially all of it. So they would respond that a wage increase would cause them to spend more than they would otherwise.
The 19% slice would be composed of people who wait tables or bartend , do yardwork , sell handicrafts , etc. – i.e. those whose incomes depend largely on demand arising from the big slice , and not so much on demand of the wealthy , or on “wages” per se. So their answer would be that an increase in jobs would cause them to spend more , since those new jobs would tend to increase their incomes.
The 25% slice ( i.e. the “none of these” responders ) are simply society’s relative winners , who aren’t motivated to spend more for any of the listed reasons – their spending simply isn’t constrained by any of those factors.
Then the two small slices , those who would spend more out of a boost in stock or home prices , would seem to me to be those who are probably not currently spending all of their incomes – they’re socking away IRA funds and such – but would use the opportunity of a windfall gain in their asset holdings as a chance to splurge a bit.