Saving and Investment

Wealth Effect

Some economists interpret today's U.S. economy in terms of a self-reactivating process: a rising stock market fueled by steadily increasing investments from increasingly affluent members of the middle class -- leading, in their view, to higher stock prices based on greater spending by those same confident investors and consumers.

They call it the "wealth effect."

  • Over two-fifths of American households now hold stocks directly or through mutual funds or pension plans -- twice as many as in the early 1980s.

  • Households now own an estimated $800 billion worth of stock options -- 10 times the amount held in the late 1980s.

  • Since the end of 1994, the total value of shares owned by American households has swollen by almost $5 trillion -- giving families the confidence to spend more.

  • This is verified by the fact that household savings has fallen from 6.2 percent of personal disposable income in 1992 to only 3.8 percent last year.

Experts estimate that higher federal tax receipts on capital gains, investment income and stock options have contributed about $60 billion to the decline in the deficit over the past year.

Economists say that strong, low-inflationary growth boosts stock prices, which increases investment and then productivity. This, in turn, helps to sustain growth and so sends share prices even higher. Likewise, as higher tax revenues on capital gains reduce the budget deficit, this helps to reduce bond yields and so drives up the stock market.

Source: "Wall Street's Money Machine," The Economist, March 28, 1998.

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