Is the “wealth effect” a myth?
If so, it means that the popping of the housing bubble won’t have the dire effect on economic growth that many have predicted.
3 thoughts on “This Seems Like Good Economic News”
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Is the “wealth effect” a myth?
If so, it means that the popping of the housing bubble won’t have the dire effect on economic growth that many have predicted.
Comments are closed.
Nice, if it were true. But that runs contrary to other studies of the “wealth effect” which indicates a significant wealth effect for both stocks and residential real estate (though I can’t find links for the latter claims). Further, I don’t buy the claims made by David Backus in the story. There is a well-defined hump in GDP around the time of the 2000-2001 stock market bubble burst with a recession in 2001. What does he expect a wealth effect to look like? Another example is the Japanese real estate collapse of 1990-1991 which coincided with a significant drop in consumption.
As I see it, there is some basis to thinking a wealth effect from residential real estate is going to be different from stocks. Homes are not liquid. It is relatively difficult to sell or refinance in order to take advantage of a rise in price compared to rapid buying and selling of stocks in a usually liquid market of vast size. Also, there are less drawbacks to a drop in real estate value. One normally can continue to live in the house (if you still owe money, it depends on loan conditions), hence it retains much of the usefulness for which it was purchased.
The author is not claiming there is no effect on the economy. The claim is that it does not drive the economy in one direction or the other. When my investments go up it has never affected my spending habits. After all these are long term investments for the typical investor, just as housing is a long term investment. The only economic affect a downturn in the housing market has made is an increase in maintenance spending on those properties you would now expect to be holding longer. In the case of portfolio investments a downturn in the market in an investment opportunity in long term investments.
The author is not claiming there is no effect on the economy. The claim is that it does not drive the economy in one direction or the other.
JJS, the Fed disagrees and they have a number of studies backing them up. Further, it makes sense economically. Maybe your spending doesn’t increase when your wealth grows, but I imagine that for most people it does.