The current “gangbusters” wealth effect on consumption

Pulled back from comments. (bolding mine)

July 20, 2015 7:01 am
These days , more people may own stocks , but the vast majority own trivial amounts. Look up Edward Wolffs stuff on wealth distribution and try to estimate how much stocks would have to go up to tease out any meaningful consumption out of the bottom 90% of the wealth distribution.

The dotcom bubble was unusual in that from the mid-90s to just after the crash decent income gains were achieved across the distribution , something that hadn’t been seen for a couple of decades. That may have contributed to any apparent consumption anomaly , as more-than-usual income flowed to high MPC households.

You can find people who can econometrically manufacture stock market wealth effects of 5-10 cents on the dollar , but they’re almost always those of a certain “persuasion” , politically speaking , i.e. mouthpieces for the 1%. Greenspan was a famous example.

Other asset prices certainly respond to a stock market bubble , like art and other collectibles , but that doesn’t do much for the economy either.

Shiller has never believed much in the stock market wealth effect , and I tend to think he’s on the right track. A couple pennies on the dollar in the US , maybe :

Housing wealth is more potent , I’m sure , but when you back out the collateral-enhanced borrowing increase , I doubt that it amounts to more than a penny or two attributable to wealth “animal spirits”.

Finally , ‘splain this :

If there’s any kind of generalized wealth effect , it should be going gangbusters right now , bigger even than the dotcom or subprime booms. That’s hard to square with this economy’s performance , which has limped along right through the wealth boom. Maybe some would argue that without the wealth boom we’d be entirely dead , but my feeling is we’ve designed the economy to generate wealth instead of gdp. In that sense , we’re doing great !

My reply

Indeed the ratio of personal consumption expenditures to personal disposable income is the highest its been since 1950 except for 2005 2006 and 2007 (the height of the housing bubble).


Note in the discussion that Brad DeLong, Dean Baker and I all agree that housing wealth has more effect on aggregate demand than stock market wealth. I argued as you do that the wealth of the rich has little effect on their consumption (which is I think limited by 24 hours in a day not a budget).

I have no idea why it is that people who assert there is a stock price effect on consumption tend to be right wing. They often argue that promoting saving is very important (hence capital income shouldn’t be taxed). In general they argue that consumption is too high not too low (and that it crowds out investment). Thus they should argue that causing low consumption is a good thing about low stock prices.

In fact, I think that usually (when the economy is not in a liquidity trap) lower consumption would be better. This is one of many reasons why I would like to effectively confiscate part of the value of stock by taxing dividends. It is exactly the wealth effect that makes the optimal tax on capital income (as correctly calculated using the standard model used by critics of capital income taxation) very high.

In any case, I don’t think one should decide what is true by group affinity for people who say one thing or another. Rather I think it is better to look at data (as I did following your absolutely correct albeit rhetorical gangbusters prediction).

GDP is way below trend because of low residential investment and low government consumption and investment. Consumption is high — much higher than one would guess with the most empirically successful model with no wealth effect (which is the paleo Keynesian consumption function).