Monday, June 2, 2014

The Wealth Effect is Failing to Drive Consumer Spending

This is an interesting article from Bloomberg that discusses the diminishing value of the Wealth Effect on consumer spending.  Although the author believes that decline in consumption from the wealth effect is due to "rich people have enough stuff", I strongly suspect it results from the lack of borrowing by the consumer.

The article is in italics and the bold is my emphasis.  From Bloomberg:
The wealth effect isn’t what it once was for the US economy..
While the wealth of American households has jumped more than $25 trillion since early 2009 amid rising equity and home prices, the pass-through to consumer spending is lagging the $1 trillion fillip that would have been anticipated historically, according to Michael Feroli, chief U.S. economist at JP Morgan Chase Co.
This means consumer spending has been exceptionally weak once wealth is accounted for, he said. With wealth gains now moderating, consumer spending could revert to what is already a weak trend, Feroli said in an April 11 report.
His calculations show that since the recession ended in 2009, households have spent 1.7 cents of every extra $1 earned in wealth. That’s less than half the 3.8-cent average implied by data between 1952 and 2009, suggesting the trend for consumer spending gains over the past three years has been less than 1 percent once the wealth effect is stripped out.
One reason for the adjustment may be that those enjoying gains in wealth are already rich, so have less propensity to increase spending incrementally. Withdrawing equity from homes has also been negative for five years.

(Ed. note) - An alternative explanation as to why consumer spending is lower than in the past is because consumers are not borrowing as much as they have in the past.  If consumers are not using the credit cards as much and paying down their home equity loans (see paragrph) above this would diminish the wealth effect.
The good news is that income expectations are starting to pick up, which should encourage the spending acceleration that greater wealth failed to spark, said Feroli, a former economist at the Federal Reserve Board.

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