NCPA - National Center for Policy Analysis

Stock Market "Wealth Effect" May Be Larger Than Thought

August 18, 1999

Economic forecasters are focusing a lot more attention on the stock market and its role in economic growth, observers report. Their predominantly timid predictions were often left in tatters as the bull market charged ahead in recent years, sending the economy surging.

  • For several decades, most economists have accepted the idea that when consumers see their household wealth increase through rising stock market or real estate values, they tend to spend somewhere between 2 percent and 4 percent of that new wealth the following year.
  • Now they are beginning to suspect they underestimated this "wealth effect."
  • As the stock market has roughly doubled in value in the past five years, so has the value of household wealth in equities.
  • Even if consumers still spend the same proportion of each new dollar of wealth, the stock market has twice the impact on spending as it did, says Joel Prakken, chairman of the forecasting firm of Macroeconomic Advisers.

Forecasting where the economy is going has never been an easy job. But if the wealth effect becomes a much larger factor than previously imagined, economists have the added burden of predicting where the stock market is headed -- no easy task.

Source: Darren McDermott, "Economists Give More Weight to Effect of the Stock Market in their Forecasts," Wall Street Journal, August 18, 1999.


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