NCPA - National Center for Policy Analysis

Continued Consumer Spending Casts Doubt on Wealth Effect

August 12, 2002

During the late, booming 1990s, economists paid special attention to the phenomenon they called the "wealth effect" -- the tendency of consumers to boost the economy even further by spending their stock market riches. It was estimated that they spent about four cents out of every $1 collected on investment profits.

But economists are now wondering how to square that with continued consumer spending at a time when Americans are losing trillions of dollars from their investment portfolios.

Some experts contend that the wealth effect pales next to real fundamentals that drive most U.S. households to spend -- which is their ongoing flow of income.

  • Some $9 trillion a year flows into households in the form of wages, salaries, interest, dividends and government pension payments.
  • Economists at Wells Fargo & Co. attribute 75 percent of consumer spending to income, and 25 percent to wealth effects.
  • Blunting the impact of the "negative wealth effect" from the stock market is a "positive wealth effect" from rising housing prices.
  • These wealth effects aside, personal income was up 3.4 percent over the 12-month period ending in June -- including a nearly 10 percent surge in pension income and other government transfer payments.

These big gains in real purchasing power owe their strengths to low inflation, low interest rates that cut mortgage payments and lower tax burdens.

Source: Bernard Wysocki Jr., "The Outlook: Forget the Wealth Effect: Income Drives Consumer Spending," Wall Street Journal, August 12, 2002.


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