Signs of a negative “wealth effect” for the… | tutor2u Economics

Signs of a negative “wealth effect” for the USA?

One of the big recession risks facing the US economy is that a sharp decline in the net wealth of millions of US households will cut deep into consumer confidence and a willingness and ability to spend on big ticket items. The so called “wealth effect” can be very powerful either when asset prices are surging ahead as they have for most of the last ten years. Or when the wealth effect goes into reverse and people find that the value of the property, shares and other financial assets are in freefall. The negative wealth effect was a noticeable feature of the last economic recession in the UK in the main due to the steep fall in nominal and real house prices.

Today the Federal Reserve Bank published their regular ‘flow of funds’ figures - and inside them was the news that US families are getting poorer for the first time in more than five years. Asset prices are falling and levels of debt are rising - the result a cut in household net worth and a rise in the stress barometer.

“US households are getting poorer for the first time in more than five years, according to figures from the Federal Reserve. Total household wealth has fallen by $533bn to $57,718bn, as falling prices of shares and other securities added to the damage from falling house prices.”

The estimated value of property dropped by over $22 billion in the final three months of 2007 and Reuters reports that “the percentage of equity that Americans have in their homes has sunk to the lowest level since 1945.”

It will take some time for the wealth effect to show through in consumer spending and savings behaviour. But the consumer sentiment figures are already heading sharply lower, and news that net wealth is slumping will do little to bolster confidence going forward.

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