Sunday, November 09, 2008

Wealth effect, consumer spending and recession

How much is consumer spending likely to fall as a consequence of stock and home price declines? If we assume a $10 trillion decline in housing and equity wealth, and a wealth effect of .04, we arrive at a decline in consumer spending of $400 billion. So, roughly 2-3 percent of GDP.

Even if we get the financial crisis fixed, we can expect a serious recession.

The figure (click for larger version) is from this 2005 paper by Case, Quigley and Shiller. Their analysis suggests a (housing) wealth effect of about .04


CW said...

Margaret Atwood offers observations on debt in a NY Times op-ed:

But we’re deluding ourselves if we assume that we can recover from the crisis of 2008 so quickly and easily simply by watching the Dow creep upward. The wounds go deeper than that. To heal them, we must repair the broken moral balance that let this chaos loose.

Debt — who owes what to whom, or to what, and how that debt gets paid — is a subject much larger than money. It has to do with our basic sense of fairness, a sense that is embedded in all of our exchanges with our fellow human beings.

But at some point we stopped seeing debt as a simple personal relationship. The human factor became diminished. Maybe it had something to do with the sheer volume of transactions that computers have enabled. But what we seem to have forgotten is that the debtor is only one twin in a joined-at-the-hip pair, the other twin being the creditor. The whole edifice rests on a few fundamental principles that are inherent in us.

Debt and the social and historical context of the credit crisis will be the subject of Atwood's 2008 CBC Massey Lecture.

Anonymous said...

See Shiller's new op-ed in the NY Times.

mock turtle said...

lots of scatter makes for difficult prognostication

unprecedented leverage, the oil shock, exotic securitization, federal debt over 50% of gdp, trade imbalance, and other factors will aggravate the financial crisis and the deep deep recession beyond the decline in consumer spending predicted by shiller's and quigley's housing wealth effect

benoit raimond said...

The relationship between housing wealth and consumption is on my view fundamentally not linear. This event is unprecedented and interpolation can not be drawn using past data (I believe).

Anonymous said...

The drop in energy prices is worth a lot. Gas prices are equivalent to ~$200B.

Nicolas said...

I am not sure a linear relation is valid here.
for big losses, you just cut everything...

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