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Home Publications Blogs Beat the Press Housing Wealth Effect: Robert Samuelson Never Heard of Inflation

Housing Wealth Effect: Robert Samuelson Never Heard of Inflation

Monday, 17 June 2013 04:01

That's what readers would probably conclude from a column headlined "Americans have record wealth but aren't spending it." The first paragraph begins:

"In the economic history of our time, June 6, 2013, ought to occupy a special place. That’s the day the Federal Reserve disclosed that the net worth of American households — the value of what they own minus what they owe — hit $70 trillion, a record that exceeded the previous peak before the 2007-09 financial crisis. Higher stock prices and a long-awaited housing recovery are slowly restoring Americans’ lost wealth. By all rights, this symbolic crossing ought to improve confidence, prompt consumers to spend more freely and increase the economy’s growth."

Okay, let's first check the story that consumers are not spending freely. If we turn to the most recent data we see that the saving rate for the first quarter was 2.3 percent. That is slightly higher than the 1.5 percent saving rate we saw at the peak of the bubble in 2005 and 2006, but it's not hugely different. (Arguably, because of the statistical discrepancy in the national accounts we should view the saving rate as being somewhat lower at the bubble peak.)

It is possible that the first quarter saving rate was somewhat lower than normal because households were taking time to adjust their consumption to the ending of the payroll tax cut. Also, they may have been spending part of the big dividend payouts that were made in the 4th quarter to beat the rise in tax rates. If we average in the 5.3 percent saving rate from the 4th quarter, we get an average of 3.8 percent for the last two quarters, 2.3 percentage points above the saving rate at the peak of the bubble. So the question is why consumption is not back to its bubble peaks if wealth is back to its bubble peak.

Samuelson tells us:

"Here’s where the process seems to have broken down. Before the financial crisis, says economist Mark Zandi of Moody’s Analytics, an added dollar of housing wealth might produce 8 cents in extra spending, and an extra dollar of stock wealth, 3 cents. The overall effect was about 5 cents per dollar of new wealth, Zandi says. Now, 2 or 2.5 cents 'seems more likely to me.'" 

Okay, let's check that one.

In the most recent data the Fed reported (Table B.100, Line 49) that households had $9,075 billion in housing equity. At the end of 2012 they had $20,609 billion in stock wealth (B.100.e, Line 6). By comparison, the Fed reports that at the peak of the housing bubble in the third quarter of 2006, housing equity was $10,979 billion. At the end of 2006 the Fed put the value of stock was $20,397 billion.

While these numbers may not seem hugely different, they are not adjusted for either inflation or the size of the economy. To make use of Zandi's wealth effect numbers we have to convert these wealth figures to the same year's prices. Since it is standard to use 2005 year prices we will set that as the base. In 2005 prices we get:


    (2005 dollars)
Year    Stock Housing
2006   $19,633 $10,568
2012   $17,530 $7,719


Okay, so in 2005 dollars stock equity was still down by more than $2 trillion at the end of 2012. (Add 10 percent to the 2012 number if you want to get closer to the first quarter figure, although no one would say the full wealth effect is felt immediately.) Zandi's 3 cents per dollar estimate of the stock wealth effect would imply a drop in consumption of $63 billion this year compared with 2006.

Adjusted for inflation, housing equity is still down by $2,849 billion from the bubble peak. (The bubble is not back, yet.) Zandi's 8 percent housing wealth effect number would imply a drop in consumption of $228 billion from lower real house prices. Adding this to the weaker stock wealth effect, Zandi's estimates imply that consumption should be $291 billion lower in 2013 than it was in 2006 as a result of a diminished wealth effect.

Turning back to the income and consumption data, disposable personal income in the first quarter of 2013 was $9,574 billion in 2005 dollars. Zandi's wealth effect numbers would translate into a drop in consumption of just over 3.0 percentage points of disposable income. In other words, Zandi's wealth effect numbers imply that we should be seeing a saving rate of around 4.5 percent currently, somewhat higher than the 3.8 percent average than we have seen over the last two quarters.

In other words, if we take Zandi's numbers seriously and we do our arithmetic right, we should be asking why consumers are spending so much, not why they are spending so little. There is not much room for the pessimism explanation that is at the center of Samuelson's piece.

So remember boys and girls, always adjust your data for inflation, then you won't end up writing silly columns in the Washington Post.

Comments (11)Add Comment
When the Economic Disease is Correctly Diagnosed and Simple to Cure - Bury It
written by Last Mover, June 17, 2013 6:25
... we should be asking why consumers are spending so much, not why they are spending so little.

Exactly. This is where Dean Baker stands out from the rest. This is the flashing gem of understanding ducked and scurried around by the others with one obscured overloaded bogged down explanation after another - or an oversimplified one in this case by Zandi, paraded around as propaganda by morons like Samuelson.

This is the kernel of root cause truth that conclusively explains in simple mechanical fashion why and how the economy has a massive hole in aggregate demand that cannot and will not be repaired by the private sector.

Targeted fiscal spending designed to tighten up the labor market is the only way out. That's why it has been buried.
written by liberal, June 17, 2013 7:36
(The bubble is not back, yet.)

Until taxes on land are raised by large amounts, there will always be real estate bubbles.

BTW, the one forecaster who saw the bubble coming years before anyone else (including Dean and Shiller) was a Georgist.
Increased wealth not zero sum game for consumption
written by Robert Salzberg, June 17, 2013 8:27
Readers of this blog likely know better than I the exact figures for how much of the rebound in wealth has gone to the top 1% as opposed to the population in general.

Accumulation of wealth at the top does not generally increase consumption since the wealthy are already maximizing their consumption.

In particular, wealth accumulated through stocks as opposed to housing wealth is much more likely concentrated in the hands of people that won't spend more just because they made a few million on the stock market last month.
Inflation of Retirement Age
written by Bart, June 17, 2013 8:36

Samuelson should know inflation. After all, he wants the retirement age for Social Security and Medicare to keep rising along with it.
written by skeptonomist, June 17, 2013 9:32
As far as the mass of consumers is concerned, what is probably most important is not hypothetical wealth or the influence of inflation thereon, it is inflation compared with income, or in other words cash flow. This is what determines how much most people have to spend beyond basic needs. Since wages and most salaries at the lower end of the scale have not been improving with respect to prices, we would not expect consumption to improve on those grounds. Rent and mortgage expense are important but are included in the CPI.

The relative few who own stocks outright probably do change their consumption according to perceived wealth, if they actively keep track of the market. Of course these people dispose of a relatively large amount of money.

Despite Dean's fixation on housing wealth, I doubt that very many people base their spending level on determining their housing equity - how would they do that, by consulting Zillow or their local realtor on a regular basis?

Both stock and housing wealth are usually correlated with economic cycles. In expansion phases people are optimistic and tend to spend more for what are essentially group-psychological reasons, not calculations based on assets as adjusted for inflation. The perception of risk changes a great deal over economic cycles and this has a great deal to do with spending. Separating real specific wealth effects from the general cyclic influence is difficult.
Ain't my obessesion with wealth effects
written by Dean, June 17, 2013 10:38

I always enjoy your ruminations telling us how people really behave. I'll contact Zandi and tell him to stop wasting time with his model and just ask you how much people will be spending next quarter.
How do people increase spending based on equity?
written by Dennis Doubleday, June 17, 2013 11:02

During the bubble, by taking out home equity loans against inflated home valuations. I know many people who did that.
Housing Wealth Effect: Robert Samuelson Never Heard of Inflation
written by Jim Hannley, June 17, 2013 12:06
I can appreciate the effect of inflation on the difference between the 2006 and 2012 figures but there may be other factors in the lack of response in consumer spending. That is the concentration of stock ownership and tight credit. It is my understanding that 80% of the stock market's equity is owned by the top 10% of investors. These uber rich have a hard time bolstering consumer spending. The other side is that increases in home equity, are only realized if those owners are able to leverage the equity through home equity borrowing. If the banks are not responsive to this collateral (and they may still be skittish after the housing bubble)then the cash to fuel consumer spending would not be forthcoming.
written by Bobby, June 17, 2013 1:13
Wealth? What a joke played on the simpleminded masses. They love feeling RICH. But illusion wealth is not real wealth. Honest wealth is not based in make believe and this market is based on debt. What a complete joke this is. Wait until the ball drops like the bond buying fiasco stops or the day interest rises! What suckers.
duh...housing is simply not wealth....
written by pete, June 17, 2013 1:49
We have future housing needs. If these rise, the value of real estate rises. We are not wealthier. Don't know where this silly notion came from. And of course wealth effects are generally irrational. This is standard Keynesian assumptions: people are stupid, the smart bureaucrats can take advantage of this. Thinking that if your house is worth more you are magically wealthier is a similar construct. Terry O'Dean recommended telling investors they were prone to behavioral problems. Reasonable economists who feel workers are prone to money illusion or illusory housing wealth effects should also push for economic education. Driving real wages down with inflation, as Krugman recommended for the PIIGs, is simply macro economic fraud.
written by fuller schmidt, June 17, 2013 4:57
Aren't wealth effects testable mathematically and widely accepted? And the idea of widespread consumer thought about the economic cycle seems like a stretch.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.