The recent example is bizarre that QE3 is pumping into the economy $85 Billion of newly created liquidity / credit and the job addition per month average is less than 200,000, which translates to a whopping $500000 per job. This leads us to reconstruct the debate that wealth effects on their own is just not enough to create consumption channels that would lead to growth in the economy.

There are two issues here, one that wealth effects stemming from financial asset growth rather than housing is a more recent study which has shown the following:

In the seminal NBER Working paper, WEALTH EFFECTS REVISITED: 1975-2012 by Karl E. Case, John M. Quigley & Robert J. Shiller, we have seen a startling conclusion, “The housing wealth elasticity in a falling market is estimated to be about 0.10 and in a rising market about 0.032. The effect of increases in housing market wealth upon consumption is positive and significant; the effect of decreases in housing market wealth upon consumption is negative and is also significantly larger. The statistical models also report a relationship between increases in stock market wealth and increases in consumption, and a larger relationship between decreases in stock market wealth and decreases in consumption. Changes in housing values continue to exert a larger and more important impact upon household consumption than do changes in stock market values.”

In this treatise what we see that some of the notions of wealth effects have been challenged with data, for example the house price/per capita income chart shows that for Texas it is rather flat whereas for California it has zoomed, which repudiates the generally accepted theory on wealth effects. The correlation of financial household wealth and consumption/income has shown significant trends, but they are smaller than the wealth stemming from house equity, “the estimated effect of housing market wealth on consumption is significant and large. In the ordinary least squares regressions, the estimated elasticity is between 0.044 and 0.18. In contrast, the estimated effects of financial wealth upon consumption are a good bit smaller. In the simpler OLS model, the estimate ranges between 0.028 and 0.075.”


The reason why this is so could be related to the transitory effects of paper wealth stemming from financial asset growth. The chart on per capita income and equity market growth shows that the per capita income had grown at a much slower pace than the equity growth, which means that the elasticity is smaller. In a market where equity indices have high volatility and the forward signals are rather mixed, people tend to cash-out far less from their equity wealth, if at all profit taking is used not for consumption but for parking in some financial assets only and could be quite temporary.

The transitory nature of financial assets (equity in particular) in times where their appreciation is not stemming from the fundamentals but in absence of fundamentals their trajectory is more induced by lack of signals in any other category of financial or real assets including commodities. In such situations it is only to be expected that consumption would remain far less elastic thus leading to very anemic job growth.

Monetary release of the likes of QE (1,2,3) have increased the systemic liquidity by an enormous amount. Such infusion at such constant blasts have almost nowhere to go but in stocks and bonds and it only takes some while to move into real investments and actual buying and selling of goods and services that create jobs. This transmission mechanism has seen some traction in certain periods, but the movement lacks continuity and sustainability as more liquidity could be having a deleterious effect on consumption goods while it could have some mild positive effects on investment goods. But the premise that investment goods would propel wealth effects to move into consumption goods and create income growth is something which has met with only lukewarm response so far.

This phenomenon of equities soaring while income growth is mildly recessionary can only be explained by the wealth effect elasticity of financial assets in particular which still leaves a lasting impression in the minds of small investors from the experiences of earlier bubbles; people rather prefer to keep the assets as liquid as possible as any illiquid asset holds a rather blurred vision as far as returns are concerned in an economy where output gap still has a lot to bridge, while capacities have not been taken out but moth-balled at best.


Procyon Mukherjee

5th May 2013

Wealth Effects On Consumption: Transitory Effects Of Financial Assets On Job Growth
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