NCPA - National Center for Policy Analysis

Link Between Investments And Spending

June 26, 1997

Economists have been earnestly searching for signs of the wealth effect -- the boost that soaring stock prices are supposed to give to consumer spending. If people's investments are growing rapidly, the theory goes, they can spend more and still meet their savings goals.

Until now, however, researchers have had very little success in finding the wealth effect. If it exists, it shouldn't be hard to find, since equity market values have increased by more than $4 trillion since 1994.

Economists at Salomon Brothers say they now believe proof of the wealth effect has been hidden in flawed Commerce Department economic data.

  • They have found a wide gap in Commerce's two measures of gross domestic product -- one of which measures the value of goods and services produced in the U.S. by counting up how much people, firms and the government spend.
  • The other measurement of GDP is based on the total amount of money which people, firms and the government get from work, investments, business profits and taxes -- that is, total income.
  • Although the two measurements should be equal, the income measurement was $98.2 billion bigger in the first quarter of this year than the product figure.
  • The Salomon analysts believe that booming income tax receipts "indicate that the income side measure is more accurate."

After hitting a record $80.5 billion in 1993, the gap -- product minus income -- began to shrink. It turned negative in late 1995, finally reaching the $98.2 billion figure.

So they expect that when the Commerce Department releases revised GDP figures for 1995 and 1996 next month, consumer outlays will be revised markedly upward. That would be the missing wealth effect: consumers on a spree, spending some of those delicious stock market profits.

But if the revised figures fail to show large spending increases, they will vindicate those economists who don't believe consumers run out and buy clothes and luxuries just because their stocks are up.

Source: Perspective, "Buried Treasure?" Investor's Business Daily, June 26, 1997


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