House prices have a far bigger wealth effect on consumer spending than share prices do.
The key conclusion of this theory is that transitory, short-term changes in income have little effect on consumer spending behavior.
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Persistent high unemployment (and the resulting effect on consumer spending) is sure to be giving Ben Bernanke some restless nights.
First, house prices have a bigger wealth effect on consumer spending, largely because more people own their homes than own shares.
Even though house prices in France, Italy and Spain have risen by more than in the United States, the wealth effect on consumer spending has been smaller (see article).
Too many people have made too much money, in bonds as well as in stocks, since 1994 to change their lifestyles radically just because their net worths shrivel a bit. (However, the wealth effect on consumer spending could surface if the market drops 20% or more.) Lower interest rates will help sustain consumer spending.
The authors find an effect of housing wealth on consumer spending that is both much lower than earlier research suggests and a lot smaller than the effect of changes in equity wealth.
They mostly remain convinced that the problem is only temporary, that the economic reports are coming in worse than their forecasts only because they under-estimated the effect the surge in energy and commodity prices would have on consumer spending, and the effect the Japanese earthquake would have on auto and technology production.
Reports blamed the effect of gas prices and interest rates on consumer spending.
Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity.
The Fed justified its second round of quantitative easing partly on grounds that the wealth effect of rising stock prices would stimulate consumer spending and, by extension, boost output and reduce unemployment.
In either case the weakening effect on the dollar should lift short-term earnings prospects for American exporters and the positive market response should spur consumer spending via the wealth effect.
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