Saving and Investment

Does The Wealth Effect Propel Consumer Spending?

Federal Reserve Chairman Alan Greenspan has said increased consumer spending due to stock market gains "has been instrumental in propelling the economy forward." This is the so-called "wealth effect" -- the hypothesis that stockowners react to rising stock values by spending more. But economists disagree on how large the wealth effect is and how fast it kicks in.

  • Cary Leahey, economist at High Frequency Economics, believes that only after the third year of 20 percent annual stock market gains did consumers start to think the gains were permanent.

  • Economist Brian Wesbury, of Griffin, Kubik, Stephens & Thompson, says that he finds "very little evidence" that the wealth effect even exists.

  • Michael Niemira, at the Bank of Tokyo-Mitsubishi, sees some wealth effect in home purchases and in saving for retirement -- but doubts that it leads to consumer spending sprees.

  • A 1997 Federal Reserve survey found that about 85 percent of households owning stock said that market performance had no impact on spending -- and only 3.4 percent said they saved less because of the bull market.

Some experts predict that a stock market fall would only have an impact on housing sales. They also surmise that a decrease in wealth would harm consumption more than increases have boosted consumption. But it would take a sustained bear market for six, 12 or 18 months to have an impact.

Source: Ed Carson, "Stock Market's Negative Wealth Effect," Investor's Business Daily, August 11, 1998.

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