Friday, February 06, 2009

Ain't Got No Home (Equity)

And therein largely lies the unique character of this recession, says Bruce Bartlett:
Economists have long known that there is a relationship between wealth and spending in the economy. According to most studies, people will increase their spending by about $5 for each $100 increase in their net wealth. Therefore, they will reduce their spending by $5 for each $100 reduction in their wealth as well.

....Just looking at the data we already have, we would expect that consumer spending would fall by $355 billion annually. If the total loss in wealth is closer to $10 trillion, as it probably is at this point, the reduction in spending rises to $500 billion per year. That adds up to a decline in the gross domestic product of 3.5% from what would otherwise have been the case, more than enough to bring on a recession all by itself.

Emerging research, however, suggests that the problem may even be worse in this recession because so much of the decline in wealth is concentrated in housing. Most research on the wealth effect is based on changes in stock prices. But people don't view changes in financial wealth and housing wealth the same way. They tend to view housing wealth as more stable and permanent, stock market wealth as less stable and more transitory. Consequently, economists now believe that the marginal propensity to consume out of increased housing wealth is higher than that for stocks--and hence the decline in consumption from lower housing wealth will be greater than standard estimates of the wealth effect imply.

Which would seem to imply that the stimulus package now being debated in congress will not help end this recession, since it doesn't seem to make any attempt to stabilize housing and stock prices.

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