The Wealth Effect
The "Wealth Effect" refers to the propensity of people to spend more if they have more assets. The premise is that when the value of equities rises so does our wealth and disposable income, thus we feel more comfortable about spending.
The wealth effect has helped power the US economy over 1999 and part of 2000, but what happens to the economy if the market tanks? The Federal Reserve has reported that for every $1 billion in increase in the value of equities, Americans will spend an additional $40 million a year. The wealth effect has become a growing concern because more and more people are investing; furthermore the Federal Reserve has very little direct control over stock prices. The numbers are staggering. Since the end of 1995, household stock holdings have doubled to more than $12 trillion dollars. And, for the first time, equities are the most valuable asset of the typical American household, not the home. When it comes to spending money, consumers take all their financial resources into consideration, from their income to their home. When an asset surges in value for a sustained period of time, such as the stock market in the 1990s, people feel flush and are willing to spend some additional money, perhaps by buying a fancy car or by taking a more expensive vacation. A good number of Wall Street analysts blame the wealth effect for today's negative savings rate.
Declining stock prices affect firms in several ways. First, lower stock prices, especially induced by profit warnings, increase shareholder pressure on managers to cut costs by laying off workers and scaling back investment. Second, the recent correction has put many stock options underwater, and it is unclear to what extent workers will bargain for more cash in place of options and how this might affect payroll costs and inflation. Third, the factors dragging down stock prices typically spur investors to demand higher risk premiums, which boosts the cost of financing business investment. This takes the form of increased spreads of corporate bond and commercial paper interest rates relative to Treasury yields and lower prices for any new stock that any firm dares to offer. Aside from raising the going price of new finance, the increased uncertainty associated with lower stock prices can spook investors so much, that the availability of finance is reduced. Since the...
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...bear market if we remain at war for a long time in the future.
We have seen in the past month, steady gains in the major stock indices. Some are stating that the bull market may be back with the war on terrorism going well, and others are insisting that the gains are only short term and that the market will retest the lows hit in mid-September. Only time will tell on how long it will take for our market to completely rebound into a bull market like we saw in the 90’s.
Sources
1.) Balke, Nathan. “The Economy in Action”. Federal Reserve Bank of Dallas.
2.) Angeletos, George , David Laibson, Andrea Repetto, Jeremy Tobacman, and Stephen Weinberg. The Hyperbolic Buffer Stock Model. 3 March 2001.
3.) Clarke, Grahm and Steven Caldwell. “Wealth in America”. Ohio State 1998.
4.) Fidelity Investments. 2001 Estimated Stock Wealth Effects on Consumption.
5.) American Express Company. 2001 American Express “ever day spending” survey.
6.) John Khoury. Yahoo Finance: http://finance.yahoo.com.
7.) U.S. Census Bureau. www.census.gov/. 2001.
8.) Swanson, KC. Is the “negative wealth” effect all its cracked up to be. The Street.com 29 March 2001.
Smith, Noah. “How to Fix America's Wealth Inequality: Teach Americans to Be Cheap.” The Atlantic. Atlantic Pub., 12 March 2013. Web. 06 April 2014. .
However prior to 2008, nearly everyone was blind to their impending doom; investors, bankers, government regulators, the general population, and even the chairman of the Federal Reserve, Alan Greenspan, a man who was considered the economic guru, was fooled into believing the prosperity America had been enjoying would last for the foreseeable future (“Rethinking” 20). By this time there had been only mild economic downturns or, at most, short periods of turmoil. Financial institutions and large corporations had grown accustomed to the decades of economic prosperity resulting from the post-war economic boom, long forgetting the lessons learned from the Great Depression (“Rethinking” 20). In fact, economists concluded that America had entered a new era of calm. After a generation of portfolio managers and investors profiting from decades of favorable returns on stocks they believed the modern economy was impervious to major calamities (“Rethinking” 20). As inflation rates fell from record highs in the late 1970s and early 1980s to the record lows that they are today, interest rates followed enabling Americans to borrow more money from
The United States is the leading economy across the globe and experienced several tribulations in the recent past following the 2008 global recession. Despite these recent challenges, there are expectations among policymakers and financial experts that the country will experience solid economic growth. Actually, financial analysts have stated that the U.S. economy will be characterized by increased consumer spending, increased investments by businesses, reduced rate of unemployment, and reduction in government cut. Some analysts have also stated that the country’s economy will strengthen in 2014 with an average of 2.7 percent or more. However, these predictions can only be understood through an analysis of the current macroeconomic situation in the United States.
... warn them about their future in the financial market. Even though Miller wrote this novel in 1991 about the trends of the 1980s, the graphic novel is still current today. In fact the distribution is even more skewed then it was 20 years ago. “As of 2007, the top 1% of households (the upper class) owned 34.6% of all privately held wealth, and the next 19% (the managerial, professional, and small business stratum) had 50.5%, which means that just 20% of the people owned a remarkable 85%, leaving only 15% of the wealth for the bottom 80% (wage and salary workers)” (Domhoff). This data shows that we should be extremely worried about the trend of the distribution of wealth in the United States. A more equal distribution is healthy for average citizens because it allows us to thrive in an environment which gives us more opportunities to move up in the economical society.
In the article “Extreme Wealth is Bad for Everyone- Especially the Wealthy” published on November 12, 2014 for The New Republic, the main argument is whether wealth is beneficial for people in terms of society, happiness, and life or not. Geared towards the common public, based on the fact that the source is for commercial entertainment, Michael Lewis successfully points out that wealth is indeed a negative influence on people’s lives. However, Lewis would have struggled with successfully conveying his ideas on the effects of wealth with a more educated audience because he failed to point out both sides of the argument. After reading this article and keeping the audience in mind, Lewis used rhetorical principles to adequately show his side of the article, the idea that the quality of people’s lives is directly correlated with the amount of wealth that person has, but struggled in portraying the benefits of wealth.
The Stock Market Crash marked a major turning point in the history of the United States. For decades the U.S. was the world’s leading superpower, but after the crash the country cascaded into the worlds most harsh depression. This crash was caused by a series of problems in the U.S. including, the over production of goods, unequal distribution of wealth and poor regulation of the stock market itself. Many can argue that the crash of 1929, strengthened the nation, allowing for policies such as roosevelt's first new deal, second new deal, the glass steagall banking act, and new regulations in the stock market, and for big business (Blumenthal, Karen). However, what can’t be argued is how the crash sparked a panic as companies, peoples, and the nation sank into the great depression.
In the 1920s, it seemed as if the stock market was the safest and easiest way of gaining money. When people heard of this, they started to purchase stocks as well, but by stock speculation. Stock speculation was the purchasing of stocks without any knowledge of the company’s financial situation, meaning people just assumed that every stock would give them a profit. To make matters worse, banks began loaning out money to investors, in order for them to purchase stocks. Soon enough, in early 1929, banks were receiving many warnings about loaning too much money. However, this did not pose a real threat to banks or investors, for they thought that the stock market was just going to keep on going up. Unfortunately, this was not the
In 1929, there was a huge event that happened in America, which called the great recession. As we know, the great recession causes a lot of negative effects not only on the American economy, but also on the world. Nowadays, although most of the economists do hardly predict recessions in the US, the past record still provides America with a little comfort. A new research indicates that the next giant recession would come soon. According to the online article the America’s vulnerable economy by printed edition, several effects have involved in accounting for this coming recession. Those effects are in terms of housing bubbles, debt bubbles and lower customer purchasing power.
Reich, Robert B. “Why the Rich Are Getting Richer and the Poor, Poorer.” A World of Ideas:
... the form of changes to the Federal Monetary policy or the installation of circuit breakers. This all leads to the optimism of the boom we have experienced since the mid 90's, the booming stock market is a natural result of profound economic changes both here and abroad. For starters, the end of the cold war not only has allowed governments to stop spending capital on the arms race and freed up money for more productive uses but it has opened up huge new markets like Russia and Eastern Europe. Companies are focusing on making money by producing goods more efficiently rather than by raising prices, thus inflation should stay low. And there is more capital in the market, coming from baby boomers saving up for retirement. In conclusion the solid footing the current market has should keep from falling like the 1987 and1929 markets when the current boom comes to an end.
Reich, Robert. "Why the Rich Are Getting Richer and the Poor Poorer." Mountain View College Reader. Neuleib, Janice. Cain S., Kathleen. Ruffus, Stephen. Boston: 501 Boylston Street, Suite 900. 2013 Print.
Highfield, Roger . "Relative wealth 'makes you happier'." The Telegraph. Telegraph Media Group, 28 June 0022. Web. 30 Apr. 2014.
One of the important economic variables being tracked is the consumer price index released by the Conference Board every month. Lately, people have claimed the economy seems to have a fair projection for consumer spending to some extent based on a 3.2 index increase in the last report. More specifically, thanks to the recent spending of the top 15% households comprised by higher income families, according to the report made by Kathleen Madigan of the Wall Street Journal in the article "Vital Signs: The 15%ers Are Feeling Better — and That’s Good for Economy’. However, the article and the chart posted note an important observation regarding the study of this trend. In 2012, the Commerce Department data implied the economy would suffer as high-income consumers felt nervous about the state of the economy generating a cutback in spending. Nevertheless, the trends seems to be different nowadays given that the economy is reacting to a new financial atmosphere in a new season. The data presented by Commerce notes wealthier families have decreased their spe...
We analyzed the market for two weeks to determine when the equity market would turn from a bearish to bullish market. Without a change in the market and a declining bond price, we decided to invest in equities according to our investment strategy, which brought us into the second phase of our portfolio. Therefore, at the beginning of February we bought shares in Sirius, Microsoft, Neon, Washington Mutual, and Nike. As assumed, the equity market continued to plummet decreasing the value of all our stocks except for our Gold Corporation stock.
The changes in the prices of goods that a consumer buys can greatly affect their purchasing decisions. This is referred to as the income effect to the consumer resulting from the change in price of the good. When the price of a good goes up, the consumer feels poorer than before. This is because they have to spend more purchasing that same good. Though the price goes, their paycheck does not increase. Ultimately, the buyer purchases less of that good. A decrease in the price of a good makes the consumer feel richer, thus making them to feel