The “Wealth Effect” on Spending from Stock-Market Price Changes

A 1% increase in the stock market increases the next year’s GDP by about 0.2%.

This post is prompted by Matthew Klein’s (very wonky) post about recent changes in QE/QT, and the Fed’s balance sheet. It prompted me to do a quick calculation that I’ve been meaning to get to: when household wealth increases due to stock-market price runups (or really anything else), what effect does that have on household spending in the next year?

I’m going to start with a bald two-part claim.

A. One dominant effect/mechanism/transmission-channel for QE/QT is via equity prices. QE gooses share prices. It “fills up the punchbowl.” QT takes it away, or at least restrains those runups.  

B. There’s a resulting (weak) “wealth effect.” If people have more money/assets/wealth, they spend more.

The wealth effect is weak, because:

1. The top 20% of income recipients own 87% of equity assets. (Aside: the top 10% of wealthholders own…87% of equity shares.)

And:

2. “Velocity of wealth”: The top 20% of income recipients only turn over about 5% of their wealth in spending each year. The bottom 80% turn over about 25% a year. These are quite consistent velocities over the past 20+ years (though the top quintile’s velocity had trended down). We can assume they won’t change very much in the next year.

So for every 1% increase in household equity asset holdings (currently a ~$625B increase), the next year’s spending increases by .17%:

($625B * .87 * .05)  +  ($625B * .13 * .25)
= $27.2B + $20.3B
= $47.5B, .17% of GDP

This is only counting the wealth-driven extra spending over the next year. It continues for ensuing years, though perhaps at a decaying rate. (Calculating that decay rate would require some quite muscular assumptions compared to the fairly straightforward arithmetic here.)

QE/QT don’t only affect equity-asset prices, of course. And equity assets are only 35% of household-sector total assets. But I hope this envelope-calc helps give my gentle readers a sense of magnitude, at least, when considering the “wealth effect” of government’s monetary and fiscal actions.