If the above analysis is correct then the US economy is even more reliant on the gains made in the stock market than people think. The wealth effect relies on the perception of rising wealth which then leads well-off people with positions in the stock market to spend more money.So maybe the Fed was right about QE and the wealth effect, i.e., driving risky assets higher than they would be otherwise by reducing the volume of safe assets — Treasuries and agencies — by paying more than they are perceived to be worth. It seems that some of the gains in equities may have spilled into increased consumption by the wealthy.
FT Alphaville
Stock market wags economy, or not?
Philip Pilkington
The Financial Times has announced that FT Alphaville is free with registration, so I am linking to Alphaville but not the Times proper, which remains behind a paywall.
7 comments:
"The wealth effect relies on the perception of rising wealth which then leads well-off people with positions in the stock market to spend more money."
Unfortunately, the money they might be spending was extracted from households…
So households spend less by an equal amount…
Looks like a net zero to me.
Is there any evidence of a non-neglegible rise in consumption?
So households spend less by an equal amount… Looks like a net zero to me.
The graph that Phil provides shows a net positive rise in household consumption. The wealthy seem to be more more than offsetting retrenchment lower on the scale, Phil surmises due to at least in part to the wealth effect. The top quintile has done well wrt respect to income and wealth, while the bottom four quintiles, not so much.
"The graph that Phil provides shows a net positive rise in household consumption."
Maybe so, but a more likely cause of increased consumption is recovery from the debt overhang and continued public spending at a level just barely high enough to sustain growth…
Beyond that it comes down to drawing down of savings or no growth in saving, implying consumers are spending instead of saving.
None of those things point to a "wealth effect".
Anything is possible but I'm a skeptic on this one. Only time will tell.
The wealth effect works both ways, however. When the stock market goes into reverse, as it surely will, then the real economy will suffer. Ultimately, there's no reason for people to hold stocks other than the underlying profit-making potential of the companies. So if prices are jacked up without improving the companies' profit-making potential, then the economy is in worse shape because assets are overpriced. Decreasing opportunity costs (e.g. by decreasing government interest payments) does not improve profits and therefore only increases asset prices at the expense of stability...
Looks like what happens is that govt spends over $4T and the SP500 companies make like 650B off of this domestically and about another $350B equivalent overseas...
So the SPs are on target to make about 1T this year on domestic govt spending of about 4.4T...
This is after taxes.
So the market cap of the SP500 is about 14T at index 1,570 so if we add another 1T to the bank accounts of the sp500 companies next year, the index goes up by the addl 1T plus a multiplier..
So sp500 should end up around 1700+ next year or so... nothing to stop it as long as govt continues to spend at about the 4.5T annual rate and they can get the same sales from their foreign operations as the previous year or so...
The $NFA injections wag "everything" these days... bank credit is in the toilet bowl and will just stay there circling unless govt meaningfully increases $NFA injection...
rsp,
While this may be right:
"The wealthy seem to be more more than offsetting retrenchment lower on the scale, Phil surmises due to at least in part to the wealth effect".
The large chart does not provide much support to the conclusion. First, it's in dollar terms, not as a percentage of GDP.
Second, I wouldn't be surprised it's nominal dollars, not real.
According to functional finance the sole reason to tax is price stability. The sectoral balance approach shows the appropriate size of the fiscal balance. Then the balance of spending and taxation is a political choice but this choice needs to be guided by economic considerations rather than purely as a matter of ideology.
The other reason to tax is to discourage behavior such as negative externalities. Economic rent is a negative externality.
There are essentially three ways to affect behavior politically, legislation, regulation, and taxation. The most appropriate means is to be selected for specific cases. Taxation may or may not be the most appropriate means in different cases.
For this reason, flat taxes and other arbitrary proposals are ill-conceived in that they are based on the mistaken assumption that currency issuers sovereign in their currency need revenue for funding.
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