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 !
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).
I agree 100% with your assessment of the (lack of) “wealth effect” of a stock market bubble.
You get a stock market bubble by having more people wanting to buy than to sell, so the prices get bid up. “Investment” in stock (except for IPO’s), does nothing for the economy — except to raise stock prices. In general, it is still a good idea for people themselves to invest in the stock market, but a stock market bubble does not help the economy at all, because to get money out to buy something else (which would help the economy), someone else has to take their money, which he might have used to buy something else, to pay you for that stock.
Stock market purchases (again excepting IPO’s), are a wash — whatever price is paid by the purchaser just goes to the seller and the broker. There is no net gain anywhere.
Indeed, the wealth of the rich does not affect their consumption, not because there are only twenty-four hours in a day, but because their goal is the accumulation not consumption. That’s how they got wealthy in the first place.
Housing prices, however, are a different matter, because some people will take out equity loans on their houses and spend it on something — usually consumption, not accumulation. This takes money that people want to save (the lenders), and puts it back into the economy to buy goods and services. It is the flow of money that is important in an economy, not the amount of money. (Yes, one can take loans against stock holdings, but it is riskier, and most people just do that so they can buy more stock — again doing nothing for the economy.)
Now, I do believe that promoting saving is very important, not for the economy, but for the individuals themselves. I agree with the idea that “consumption crowds out investment,” but only at the individual level, not economy-wide. For one person to consume, someone else must produce. To produce, he must invest in the means of production. The only way for consumption to be higher is for production to also be higher.
While it seems we agree on all that, I don’t understand where you are going with the dividend tax. Dividends are already taxed. A company earns some income, that income is taxed, and from the remainder dividends are paid. Then the recipients of those dividends are taxed on them. Dividend payments are not tax deductible, so they are taxed at both the corporate and individual levels. (True, those in the 10% and 15% brackets pay no dividend tax, but they hold a negligible amount of the dividend-paying stocks.)
Assuming a marginal corporate tax rate of 35%, and a dividend tax of 15% (for most people — some will be taxed at 20%), that’s already a 50% tax on that income. How much do you think the government should take?
Lastly, I can understand how low residential investment reduces GDP — it is less production. But I do not see how lack of government consumption reduced GDP. The government, generally, produces little of value. (Yes, the F35 is very expensive, but I think you will agree that its value is much lower.) Government consumption must be paid for by taxes, which means that those paying the taxes will not be spending that money on something else (like residential improvements). Or it can be paid for by borrowing money, in which case the people lending the money to the government won’t be spending it on something else or lending it to someone else.
The primary way for federal government spending (investment) to really increase GDP is in infrastructure. Roads, bridges, trains, and public transportation in general have a beneficial effect on the economy in general (“the General Welfare… of the United States”).
Now, to contradict myself, maybe I need to go back to the FLOW issue. If those paying the taxes or buying the bonds would otherwise just sit on that money, then perhaps it is better to take or borrow it, even to seemingly waste it on those who don’t (won’t) work, the government contractors who charge $800 for a MILSPEC hammer, failed health insurance exchanges, etc. Generally, the people who “earn” that money are going to go out and spend it. So perhaps keeping the FLOW moving, even if the reason for the flow is itself worthless, is itself a net positive.
Even so, our debt levels scare the $H!T out of me.
Sorry I’ve gone on so long. It’s a fascinating topic. Thanks for letting me ramble.
Well that’s a lot of comment. Government consumption plus investment (G) is counted as part of GDP — it is a component of final aggregate demand equal to consumption plus investment plus government consumption plus government investment plus net exports.
The discussion here is mainly about the current situtation of low demand and interest rates at the zero lower bound. In this rare situation, higher demand causes higher production. The point about f-35’s is that they don’t contribute to aggregate supply.
Now sometimes GDP is limited by supply so higher G just causes higher prices not more production. In most other times, GDP is basically what the Fed thinks is consistent with stable low inflation. In this normal case, higher G leads to higher interest rates (by the Fed) and lower investment.
It is only in the current extraordinary circumstances that higher demand causes higher production.
Yes dividends are taxed (although the double taxation was reduced by the second Bush tax cut). My position is that this is a good thing. I note that for shareholders what matters is the average tax rate on profits not the theoretical 35% rate. In practice the average tax rate is much lower than the marginal rate. The relevant margin for firms is how much to invest and how much to pay as dividends. Because of the investment tax rate, the relevant marginal corporate income tax rate is currently roughly zero.
Finally back to the original issue. The stock price effect is not on supply but demand — if stock prices are high, shareholders feel richer and consume more. The consumption is from their income not from sales of their shares, but the amount should (and according to the data does) depend on the price of their shares.
Marko dismisses the consequences of the wealth effect with this:
but they’re almost always those of a certain “persuasion” ,
politically speaking , i.e. mouthpieces for the 1%.
Greenspan was a famous example.
Since 2009 it has been the stated policy of the Federal Reserve to “Increase asset prices”. Ben Bernanke, and now Janet Yellen, have pursued monetary policy accommodation at a level never seen before in history.
Both Ben an Janet have repeated the mantra that aggressive policy and strong Dow Jones are good for the economy. They have pushed this policy to a much greater extent that Greenspan ever did.
Yellen and Ben do not fit Marko’s mold.
In Japan, the Central Bank is buying common stocks with the objective of increasing wealth. They have been doing this for two years in large amounts. The Japanese believe in (and are now dependent on) the wealth effect.
In the past month China’s market fell a jaw dropping 30%! The government stepped in to prop up the market. Hundreds of billions of printed money was needed to avoid an even deeper sell off. There was concern of social pressures if the sell off got out of control. The Chinese clearly believe in (and fear) the wealth effect.
Again, It’s a mistake to paint stripes on those who gear economic policy around equity markets. It’s also a mistake to underestimate the consequences of the markets on overall economic performance. After all, we have 1929 and 2009 to point to.
Well, the whole idea of corporate income taxes seems, to me, completely ludicrous. Just tax the individuals when they get the money. Tax employees when they are paid; tax bondholders when they get the interest; and tax owners when they get dividends or capital gains. Then, investment and improvement would not be structured around the tax code, corporations and business sectors would not be lobbying for tax breaks, and those brainiacs who do the taxes for corporations could be put to constructive use.
I disagree on the average-tax-rate vs. marginal-tax-rate difference. When you get a bonus, you don’t care that your average tax rate is only 15%, you care that the government just took 45% of your bonus. So it is with dividends — they are the last thing out after all deductible expenses are taken, and so are subject to the marginal rate on the net taxable income, not the average rate on the gross income.
But back to the original issue, your comment (“The consumption… should (and according to the data does) depend on the price of their shares”) seems to contradict your original post (“I argued as you do that the wealth of the rich has little effect on their consumption”).
Are you saying that this stock price effect on consumption is primarily limited to those who are NOT rich?
Not taxing the corp means you are not taxing the entity that is using the government provided capital stock (tangible and intangible assets) independent of the government provided capital stock used by the owners in their personal lives.
2 different entities using in different ways for different means what government is providing.
Or you can double tax the owners. First for the business use of the government capital and then for the individuals personal use of the capital.
“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 ….”
That’s what I admire about right-wingers – they have absolutely no requirement that their arguments be internally consistent. They can flip back and forth freely , as it suits their purposes.
They want to show that a wealth effect exists as a justification to use monetary policy rather than fiscal policy to manage the economy. It’s especially important under a QE regime. They don’t want to admit that monetary policy is mainly about bringing demand forward via debt creation , so they distract attention away from the debt bombs by pointing instead to the asset bubbles and saying ” See? That’s what’s driving consumption – all that fresh wealth ! ”
“…Consumption is high — much higher than one would guess with the most empirically successful model with no wealth effect ….”
I could dispute the “high” bit by arguing that trend pce still hasn’t caught up to “potential” , similar to overall gdp , but I won’t since we were basically Greece in the 2000s and so we probably shouldn’t rely on those numbers to evaluate current or future trends.
I still think a lot of the housing wealth effect is manifested as increased borrowing , acting explicitly as pledged collateral or implicitly by simply dressing up your balance sheet. Household debt growth rates started increasing ~ the end of 2011 , about the same time the net worth/gdp turned up solidly.
However I can accept that there’s some real wealth effect as posited by all the PIH crap – perfectly rational consumers with perfect foresight recalibrating their budgets down to the penny , adjusting their expected lifespan to the hour and minute , then allocating their wealth windfall so as to achieve maximum utility with their consumption , and then repeating the process when the markets close tomorrow afternoon , and again every day thereafter. I’m sure there are a few creeps out there that act that way , so I can’t discount the phenomenon entirely. I just don’t think it’s a major driver.
In the end, the vast majority of citizens of a given economy still need to be able to make the payments. Wealth means nothing to them if they don’t have the income to cover the monthly bill.
The liquidity trap was the results of banks having nothing but air under their loan portfolios because the people who were making the payments could not.
That “could not” make the payments part as I’ve noted and then Kreger noted in is Gatsby Effect that $1.1 trillion in income had shifted to the 1% from the 99% and in his calculations represented $450 billion in consumption.
How stupid was this economic design? Build a money machine that depends on people being able to make payments while the machine works also reduces the money used to make payments by those who need to make payments.
The money boys and girls played both ends against the middle and the ends smacked into each other causing the big crash.
I wouldn’t worry too much about ‘oo pays the taxes. The rich, especially the corps, just pass the taxes through as higher prices or lower wages, and there are undoubtedly tangled economic effects that follow from that.
Of course the whining will go on, some of it because people don’t see so good, and some of it because it has political advantages.
As for consumption crowding out investment. I don’t think so. When the bank lends you money to invest in your business because you expect to make money from someone consuming your product, it essentially creates that money… in the hope that your investment will create enough “wealth” to pay back the money plus interest.
What creates investment is the prospect of consumption, and what creates consumption is new products that are desirable simply as consumption or because they can increase “productivity.” And of course money in the hands of consumers, not to say investors.
And that seems to be a product of investor confidence. And if part of that looks circular, it’s because it is. After all, it’s a business “cycle.”
And it doesn’t much matter whether the government is doing the investment (and hiring) or the private sector, assuming a reasonable degree of honesty and competence, in both sectors.
Which we can’t always do, it seems.
” Yellen and Ben do not fit Marko’s mold.”
They , essentially everyone else at the Fed , essentially all of Wall Street , and all but a rare few politicians fit my mold precisely.
Yellen and Ben aren’t lefties , and if you’re not a lefty in this kleptocracy , you’re either one of , or pimping for , the 1%.
Warren elimination of the corporate income tax is, in principle attractive — for one thing it would make it easier to make the tax code highly progressive. The problem is that personal income can be disguised as corporate income. In the UK most automobiles belong to corporations and are untaxed fringe benefits.
If purchases of consumer durables is called investment in the corporations capital stock, income so spent would not be taxed. Also if entertainment is on a corporate expense account it isn’t taxed (also in the USA also now). A zero corporate income tax rate is a huge invitation to tax evasion.
Marko I think I have a clue. Right wing economists are mostly fresh water real business cycle economists who think consumption is excessive. However, there are also market monetarists who tend to be conservative and stress the effect of QE on asset prices and hence consumption.
I wouldn’t ever recklessly accuse any economist of logical consistency, but I think there are two very different schools of conservative macroeconomists.
Daniel, I disagree that they are “two different entities.” A corporation is nothing but a collection of owners, employees, bondholders, and customers. If the corporations pay taxes, then the owners get less in dividends and capital gains, the employees get less compensation, the bondholders get less interest, the customers pay higher prices, or a combination of all of those.
So yes, “double tax” the owners. Right now, we have lower rates for dividends because dividend income IS double-taxed (and long-term capital gains are treated similarly). Tax both as ordinary income, and get rid of the corporate income taxes. The biggest benefits would be to put all those accountants and tax attorneys to productive uses and to eliminate a huge reason for corporate campaign contributions and lobbying.
Robert, cannot automobiles be deducted as a business expense in the United States? So why don’t we see that problem here? (I suspect it is actually because of better public transportation in the UK.)
Anyway, just include such perquisites as income, and then the individual with the car would have to write off the business mileage.
Yes , you’re right about the market monetarists being the loudest cheerleaders in that regard.
I have a fairly condensed , rule-of-thumb view of most of what passes for debate in mainstream economics , the same view that serves me well in understanding what’s happening in other areas like foreign policy , civil liberties , terrorism , and so forth — to wit : Absent overwhelming , irrefutable evidence to the contrary , everything you read , hear , or absorb thru your skin is part of The Big Lie.
I suspend the rule when I travel out of the country , since I don’t know what’s customary everywhere else and so I feel I should give them the benefit of the doubt.
what would be the point of investment capital if there were no buyers? and buyers are the ‘consumers’.
Warren let me disagree on a few points. In two comments.
One it is too reductionist to say that the rich are motivated by accumulation rather than consumption, in part because there are only 24 hours in the day. First of all people like Larry Ellison have proven there ARE ways to consume conspicuously no matter how much money you have. For example you can essentially buy the America Cup competition AND buy 99% of one of the major Hawaiian Islands. But more generally you have omitted the third possibility: which is display. As a medievalist by training I have seen abundant evidence that what motivated chieftains and then kings and emperors was not personal consumption as much as the chance to display wealth and hospitality. Meaning that you could become famed by being KNOWN to be so rich that you could spend without care, and not just on yourself but on your supporters or simply via charity. In this way display has a function in between accumulation and consumption and where a thousand years ago that might manifest itself in palaces and cathedrals today it can happen with the pages of the Forbes 400 issue.
…have omitted the third possibility: which is display.
I give you one Donald Trump. (sorry, could not resist)
Well, I agree about the Big LIe, or the Big Befuddlement. You have to reember that these people have been lying to themselves since they were freshmen at Harvard and were let in on the Big Secrets by Famous Men.
On the other hand, you could just as well, or better, tax ONLY corporations. Since the corps would adjust the wages they pay and the prices they charge, the effect on “the economy” would be zero. and since the people would not be paying any tax, they would vote for larger taxes and we could get some work done.
Or, as long as you are not running a system where the rich pay no taxes and the poor pay what the traffic will bear, you could leave things as they are and let the market sort them out.
I don’t know anyone who is paying the “double tax” who is going without supper.
Ah shit my Internet provider gobbled up a long comment. Let me try a (somewhat shorter).
The idea that corporations are double taxed is certainly taught, at least it was to me, on day one or two of either Intro to Business or Business Law. But it is logical and practical crap.
Take the following: Bruce uses post-tax income to buy product A from proprietor Bill. Bill pays tax on his income and uses his post tax remainder to buy product B form proprietor Sally. Who pays tax on income and pays product C with her post tax income from Dave. What do these taxes buy Bruce, Bill, Sally and Dave? Well even in Libertarian land it buys State police protection for their persons and property with the latter including interests in valid contracts. Now in this scenario a post tax dollar originating with Bruce gets taxed three more times with that multiple tax being justified by the fact that all four participants in the chain get value for their tax dollar.
But in Warren’s model Bill just has to become BillCo to have his income be tax free. On the basis that it will just be taxed when it passes to Sally. Which in turn might prompt the formations of BruceCo and SallyCo with everybody not paying tax because the dolar ends up being taxed when it passes to Dave. But none of that reduces the call that Bruce, Bill and Sally or their respective Corporations made on State police powers. That Dave ends up being taxed shouldn’t mean that Bruce and Sally can have a contract adjudicated in a court for which they are not actually paying costs in full.
So unless you can come up with a reason why Sole Proprietor Bill should pay individual income taxes as a S-Corp while Bill’s Shoes Inc should be tax free as a C-Corp just because a portion of its income is payable out to Preferred Stockholder Bill the idea of ‘double taxation’ is not meaningless as much as moot. After all the logic is never applied to simple chains of transactions between individual proprietors or to what a lot of corporatists prefer as an alternative – which are often VATs applied at multiple stages from raw goods producer to final consumer.
“Corporations are people my friends”. Yes legal persons who use governmental services on their own account and need to pay taxes on them. (Now if my ISP cooperates)
Well as usual that wasn’t a “shorter” at all.
And Dan I fully grant you Trump. There is no doubt he is a massive consumer of bodily pleasures natural or not, but there seems equally little doubt that he gets as much pleasure or more out of declaring “Man this girl had the greatest lay she or any woman ever had last night!” The man lives for Display. With Accumulation just being another Shiny. “See this piece of paper says $10 billion! Just like I said! Just before I dictated it to my secretary!”
If they were not 2 different entities, the liabilities would not be different.
You can’t have it both ways. Well, in this time in the US it appears you can, but…
In your “collection” you have simply listed the sub categories the comprise the operational components of a corporation. Together they make up the legal entity corporation. Which is an entity of it’s own which any day now may even have the right to vote. Now, how will you square that round peg?
After all, a nation is just a collection of…
As I have said before, no corporations of any kind should be allowed to contribute to campaigns or to advertise for candidates. Only those who are registered to vote should be allowed to make campaign contributions, and they should only be allowed to make such contributions to candidates for whom they can vote.
Yes, I have listed the components. So why tax the whole when we can tax the components when they get the money?
“On the other hand, you could just as well, or better, tax ONLY corporations.”
That does not eliminate the two primary problems with corporate income taxes — the wasted intellect that goes into computing (and avoiding) those taxes, and the lobby (and outright buying) of politicians by corporations to get tax breaks.
Bruce, Bill would have to get the money out of BillCo somehow, to spend it on himself. If BillCo buys a house for Bill and his family to live in, the value of that housing is taxable income to Bill, just as it is now. If BillCo buys a car for Bill, that car would be taxable income to Bill, just as it is now.
The why has been answered by both Bruce and I. The corporation is a separate entity. You can not deny this (though you are trying). If they were not, they would not hold separate liability from their owners even if it is one person owning all of the stock.
Look at it this way, the corp is paying society for your freedom from it’s liabilities when it pays income taxes. Being a corporation is a privilege, it is not a right. It is a special privilege. You want that privilege, you pay. You don’t want to pay, We take it away.
Or try this, you clone yourself and designate it separate from you and set it to making money while you go about your activities. If it screws up, no harm done to you. In fact, you can kill it off and make a new clone. Is it you making the money? You die, your clone continues to live? Is it you making the money?
The only corporations that do not have owners are not-for-profit, and so not pay income tax anyway.
The point of eliminating the corporate income tax is not to change how much a stock-holder pays in taxes, but where that taxation happens. The reasons for wanting to do that are to eliminate the waste of intellectual capital that goes into computing and avoiding corporate income taxes, and to remove the primary incentive that corporations have for buying (renting, anyway) our representatives in Congress — tax breaks.
If the total taxes paid on that income by the owners, as now with both corporate and personal income taxes, or as I propose with just personal income taxes, is the same, what advantage is there in having that tax split between corporate taxes and personal taxes?
Anyway, I don’t think we’re going to convince each other on this, and it is off topic. Sorry for that.
Back to the topic (and I thought I posted this but I don’t see it)….
Is it possible that the “wealth effect” is actually a “wealth cause”, that it is not the increase in the value of one’s house or stock that causes greater consumption, but greater consumption (more economic activity) that causes stock and housing prices to be bid up?
” If BillCo buys a house for Bill and his family to live in, the value of that housing is taxable income to Bill”
Do you know that that is true is all cases? Do companies that provide ex-pat employes accommodation in company owned guest-houses have to count that as taxable compensation? If Chairman Bill spends almost all of his time traveling on business, half on the corporate jet and staying in Five Star Hotels, and half traveling and entertaining clients on the company yacht while staying on board at night does he pay tax on the full value of those hotel rooms or on an aliquot share represented by the cabin on the yacht? I don’t think so but am willing to take instruction.
As to this:
“That does not eliminate the two primary problems with corporate income taxes — the wasted intellect that goes into computing (and avoiding) those taxes, and the lobby (and outright buying) of politicians by corporations to get tax breaks.”
That is much like the murderer of his parents asking mercy on the basis of being an orphan.
The tax code is complicated because corporations try to get tax breaks inserted by fair means, or as you point out, by foul. Essentially you are arguing that since corporations are on the whole soulless sociopaths who will do anything to avoid paying their share of services consumed that they should be rewarded by “simplifying” the tax code through elimination of the liability.
Look if you really want to turn the U.S. into Greece this is the way to do it: make tax enforcement on the wealthy so complicated that anyone with the will and means to hire the right lawyers and accountants can defeat it and so governments just give up. Or in the words of America’s Greatest President (during the timespan from Jan 2001 to Jan 2009):
You know who makes this same case? Besides Greek shipping magnates? The Mafia.
the trouble with this whole conversation about ‘oo pays the tax is that it assumes taxes are somehow only about “fair”..
or in your case saving all that precious intellectual capital, because we know ordinary tax payers don’t use up any intellectual capital when they figure their taxes…
leaving that aside, consider the SS “tax.” “most economists,” they like to say, say that the employer’s SS tax is “really” the employee’s money. they say that when they want the employee to feel that his ROI is really small. later they turn around and call SS a “jobs kiling tax.” apparently paying the employee “his own” money kills jobs.
but my point here is that there is some reason why the SS tax is divided between employer and employee, just as the corporate income tax is divided between “before dividends” and “after dividends.” it might be only psychological. it might have some effect on the decisions the corp makes, or might just be the best way to make the medicine go down. but it has nothing to do with “fairness” or “intellectual capital.”
if anything, a “corporations only” tax would put the burden of figuring taxes on those most able to do the figuring: the corp accountants… unless you are supposing that without taxes the corp won’t need accountants. and the collecting of taxes would be a lot easier: we know where you (the corps) live.
and presumably the corps might be in a better position to understand what taxes buy them than the average viewer of Fox News.
meanwhile your strange argument about the wealth effect makes me think you can’t be serious.
i have heard people claim that the cigarette tax is a “regressive tax” and should be repealed as it is unfair to the poor.
i think i know who makes that claim. but it suggests to me that arguments about “oo pays” taxes are mostly nonsense.
” Is it possible that the “wealth effect” is actually a “wealth cause”, that it is not the increase in the value of one’s house or stock that causes greater consumption, but greater consumption (more economic activity) that causes stock and housing prices to be bid up? ”
Yes , and it’s good you mentioned it. A lot of such bi-directional causality is simply ignored in economic research if it runs contrary to the point ( i.e. propaganda ) the author is pushing. Think about the entire theory of supply-side economics , for example.
Finance guys are well aware of the importance of PCE to the overall economy , and thus to stock values. I suspect there are multiple custom-designed “PCE leading indicators” in the various finance shops that are used to predict future PCE data releases , facilitating the front-running of any expected market moves.
Fed funds rate changes as well as significant movements in hourly wages have been shown to be leading indicators of PCE , though not reliably by themselves. The guys who can fashion a good leading indicator for this probably command the big bucks.
It seems to me that even something like the Atlanta Fed’s “GDP Now” forecast has to somehow account for PCE that hasn’t been officially released.
I just found this 2009 paper that claims that Google Trends data does a better job at forecasting consumption than other survey-based consumer sentiment indicators :
“[Meanwhile,] your strange argument about the wealth effect makes me think you can’t be serious.”
I’m sorry, I did not know I had made any argument about the wealth effect at all.
I have asked for clarification on what the original post said, and I posited the possibility that we have cause and effect reversed, but I have not actually argued that that is the case, since I have no evidence to support it or to refute it. I was really just throwing the idea out there to see whether anyone else had evidence either way.
I guess we have a failture to communicate. I took your “is it possible” as an “argument” in the sense that an argument is an extension, not in the sense that it is an attempt at proof.
and i didn’t take it seriously because i assumed that it was a given that “greater consumption… causes …prices to be bid up”… while “the wealth effect” seems to me to be an entirely different phenomenon… not unrelated, but just something that would be talked about in a different context than “people have more money so the price of houses go up”… a rather expected relationship. that people might spend more not because they have more money, but because they look at the “value” of their house going up… is rather less intuitive.
so, no offense meant.
I think as Marko has suggested that your wealth effect question hits on a problem with econ thinking and thus their study. Though, I would be less polite and suggest they have an issue with the fabled chicken or the egg question.
I suggest the answer is determinate upon the other events in which the moment of the question of wealth effect is asked. Example, stocks. More buying, more wealth. But housing, more buying could be driving the wealth up if the supply is relatively less than the demand. But, that excludes those who do not extract the extra in the new market value of their home, which means there is no more consumption from those. If this number is greater than those extracting the added market price, then were is the wealth?
Back in the 07/08 period on this blog there were often discussion regarding how one should view their home. Was proper to view it in simply market terms (this did seem to be what was being pushed as the proper interpretation). Maybe, the home/house had value to the owner not considered in the simple terms of “what can I get for it”? I think this intangible value was understood prior to the push to financialize our economy.
If, as Kreger showed $1.1 trillion of income has shifted to the 1% (my posted number here years ago was $1.4 trillion/year income) and it represents $450 billion in activity, but that activity did not happen, then where’s the added consumption. If it did happen, and I believe it did, but was via debt from value extraction of the home, instead of from wages do to productivity gain, then where is the added consumption?
Lastly, in one of my postings a few year ago I noted a study that showed the extracted money was used simply to maintain status quo as it related to standard of living, then where was the added wealth?
We can then go further with this and not a question asked here at AB: What is money?
Heaven help you if you should buy or build a house with the idea of making it a “home.” They won’t let you. The house police. The only thing you are allowed to do with your house is protect it’s resale value. That means you are not allowed any idiosyncrasies. It exists as a medium for generating revenue for the banks.
And I guess no one ever asked themselves the question, “Okay, so now my house is “worth” a million dollars. So if I sell it, where am I going to live? (what would it cost me to buy another house?)”.
You both have hit the nail quite squarely:
“What is money?”
“[If] I sell my house, where am I going to live?”
Adam Smith says that money is two different things — a medium of exchange and a measure of wealth. It is the confusion of one with the other that is the problem. If you sell your house and buy another for the same price, does it matter what that price really is (neglecting commissions and taxes, of course)?
It is great, though, if you can retire, sell an expensive house, and move to a cheaper part of the country.
that happened to us. all them californians sold their million dollar starter homes and came up here, paid three times the going rate for a house and put our property taxes out of reach.
money is all of those things, but it is also an illusion.
Like Napoleon said of History — “a myth agreed upon.”
like Napoleon said about perfidious Albion.
I just read the comment thread. It includes an impressively broad range of opinions (all left of center to lefty but various and firmly held). I am impressed that the tone was civil, polite and respectful throughout (this may be because I personally have been travelling). I guess I just want to praise the commenters in this thread.
Good job and thanks for all the interesting thoughts and responses and responses to responses.