March 2018 Weighing the Wealth Effect BY MARK ZANDI, BRIAN POI, SCOTT HOYT AND WAYNE BEST Abstract Consumers are powering the U.S. economy’s growth. Businesses, housing, government and global trade are all modestly contributing to growth, but it is the consumer who is key to the economy’s performance. Consumers are not spending with the abandon they did in the boom and bubble prior to the Great Recession, but they are stalwart in their spending. Benefiting consumers are strong economic tailwinds. The job market is healthy, creating lots of jobs across all pay scales in most regions of the country. With unemployment at near 4%, the economy is at full employment. Wage growth has been somewhat disappointing, but it is slowly picking up, and because of low inflation, real wage growth—nominal wage growth less inflation—is improving. Household leverage is low and credit is increasingly ample and cheap. Gasoline prices are off their recent bottom, but they remain low by most historical standards. Another critical tailwind to consumer spending has been rapidly rising asset prices—most important, stock and house values. Stock prices are up a robust 20% over the past 18 months, despite the recent market correction, and 300% since their nadir during the recession. House price gains have also been impressive, rising a robust nearly 10% to new highs over the past 18 months, and 40% since their nadir five years ago. The resulting increase in household wealth has supercharged consumer spending via the so-called wealth effect—the impact on consumer spending of changes in household wealth. The importance of the wealth effect has significant implications for the economic expansion. With stock prices now seemingly richly valued and house prices fairly valued, further outsize gains in asset prices appear less likely. If consumers are to continue spending as strongly as they have been, stronger wage gains will be needed. Moreover, the real possibility of a correction in the stock market, particularly as the Federal Reserve normalizes monetary policy, poses a meaningful threat to consumers and the broader economy. In this paper, we quantify the wealth effect based on data on household stock and financial asset holdings from Equifax and retail sales estimates based on Visa credit and debit card data that are modeled to represent all forms of payments, including cash and checks. These data are available for states and metropolitan areas, and thus provide numerous data points to refine our econometric estimates of the wealth effect. We examine differences in the wealth effect across retail spending categories, the lags in the wealth effect, and possible asymmetries in the wealth effect due to rising versus falling asset prices. ANALYSIS Weighing the Wealth Effect BY MARK ZANDI, BRIAN POI, SCOTT HOYT, AND WAYNE BEST onsumers are powering the U.S. economy’s growth. Businesses, housing, government and global trade are all modestly contributing to growth, but it is the consumer who is key to the economy’s performance. Consumers are C not spending with the abandon they did in the boom and bubble prior to the Great Recession, but they are stalwart in their spending. Benefiting consumers are strong eco- stronger wage gains will be needed. More- spending over the past year, is thus due nomic tailwinds. The job market is healthy, over, the real possibility of a correction in to the wealth effect. The wealth effects are creating lots of jobs across all pay scales the stock market, particularly as the Federal especially large for spending on travel and in most regions of the country. With unem- Reserve normalizes monetary policy, poses home improvement, and small for groceries ployment at near 4%, the economy is at a meaningful threat to consumers and the and drugstores. full employment. Wage growth has been broader economy. The wealth effects are at their maxi- somewhat disappointing, but it is slowly In this paper, we quantify the wealth ef- mum one year after the change in wealth, picking up, and because of low inflation, fect based on data on household stock and and they are bigger when asset prices are real wage growth—nominal wage growth financial asset holdings from Equifax and falling than when prices are rising. This less inflation—is improving. Household retail sales estimates based on Visa credit suggests that if we were to suffer a major leverage is low and credit is increasingly and debit card data that are modeled to correction in stock price or housing values, ample and cheap. Gasoline prices are off represent all forms of payments, including consumer spending and the broader econo- their recent bottom, but they remain low by cash and checks. These data are available my would be substantially impacted. most historical standards. for states and metropolitan areas, and thus Another critical tailwind to consumer provide numerous data points to refine our Consumers lead the way spending has been rapidly rising asset econometric estimates of the wealth effect. U.S. consumers have been the strongest prices—most important, stock and house We examine differences in the wealth effect and most consistent source of growth in the values. Stock prices are up a robust 20% across retail spending categories, the lags current economic expansion. During the past over the past 18 months, despite the recent in the wealth effect, and possible asymme- eight years of the expansion, consumers market correction, and 300% since their tries in the wealth effect due to rising versus have accounted for nearly three-fourths of the nadir during the recession. House price falling asset prices. gains have also been impressive, rising a We estimate that Chart 1: Consumers Power Economic Growth robust nearly 10% to new highs over the the wealth effect Share of GDP growth due to cons. spending in expansion yrs, % past 18 months, and 40% since their nadir on total consumer 140 five years ago. The resulting increase in spending is 4.5 cents. Share of GDP growth due to consumer spending household wealth has supercharged con- That is, for every $1 5-yr MA 120 sumer spending via the so-called wealth change in household effect—the impact on consumer spending wealth, consumer 100 of changes in household wealth. spending ultimately The importance of the wealth effect has changes by 4.5 cents. 80 significant implications for the economic ex- Close to one-fourth pansion. With stock prices now seemingly of the growth in 60 richly valued and house prices fairly valued, consumer spending further outsize gains in asset prices appear during the current 40 less likely. If consumers are to continue economic expansion, 60 65 70 75 80 85 90 95 00 05 10 15 spending as strongly as they have been, and one-third of the Sources: BEA, Moody’s Analytics 1 Copyright© 2018 1 ANALYSIS �� Weighing the Wealth Effect economy’s growth (see Chart 1). The stron- equity lending has Chart 2: Wealth Surges, Saving Rate Falls gest gains in spending have occurred in the come back to life, % past several years, as in the aftermath of the as higher house 18 8.5 Great Recession many households strug- prices have increased 16 Personal saving rate (L) Assets-to-income ratio (R) 8.0 gled with foreclosures and deleveraging. homeowners’ equity 14 7.5 Critical to consumers has been the im- and lenders are more 12 7.0 proving job market. Job growth has been comfortable extend- 10 6.5 consistently robust during the expansion, ing loans given much- 8 averaging well over 2 million jobs per year. improved credit qual- 6.0 6 This is about double the pace of job growth ity. It is also easier 4 5.5 needed to absorb the slowing growth in the to qualify for a first 2 5.0 labor force, and thus unemployment and mortgage loan to refi- 0 4.5 underemployment have steadily declined. nance or purchase a 60 65 70 75 80 85 90 95 00 05 10 15 At currently just over 4%, unemploy- home, although stan- Sources: Federal Reserve, BEA, Moody’s Analytics ment is consistent with a full-employment dards are still a bit economy. Indicative of the tightening labor tight compared with 2 market are the record number of open job pre-housing bubble historical norms. The owned by households has risen from a low positions, across nearly every industry, only exception is vehicle lending, as vehicle of not quite $16 trillion to about $24.5 tril- and the rising quit rate, as workers jump to lenders have responded to a weakening in lion. Over the past two years, house prices better jobs. Millennial workers have been credit quality and have tightened their stan- are up 12%, equal to an increase in hous- particularly aggressive in moving to higher- dards, contributing to the recent slowing in ing wealth of close to $2.5 trillion. paying and more suitable jobs. vehicle lending and sales. The impact of changes in household The tight labor market is prompting Until recently, lower gasoline prices also wealth on consumer spending is the strong businesses to give their workers bigger provided a boost to consumers. Consum- inverse relationship between wealth and pay increases. Wages as measured by the ers currently spend about $100 billion a the personal saving rate (see Chart 2). The employment cost index—the most accurate year less on gas and on other energy, not simple correlation coefficient between the measure of wages—have accelerated from quite 1% of spending, than they did before ratio of household assets to disposable in- close to 1.5% per year a few years ago the collapse in oil prices several years ago.