Stock Market Wealth and Consumer Spending

Martha Starr-McCluer (*) This article investigates the effects of stock market wealth on consumer spending. Traditional macroeconometric models estimate that a dollar's increase in stock wealth boosts consumption by three to seven cents. With the substantial 1990s rise in stock prices, the nature and magnitude of this "wealth effect" have been much debated. After describing the issues and previous research, I present new evidence from a well-known consumer survey. The results are broadly consistent with life-cycle saving and a modest wealth effect: most stockholders reported no appreciable effect of stock prices on their saving or spending, but many mentioned "retirement saving" in explaining their behavior. (JEL E21, E30, D12) I. INTRODUCTION The relationship between stock market wealth and consumer spending has been a subject of long-standing interest. Traditional macroeconometric models estimate that a dollar's increase in household wealth boosts consumer spending by three to seven cents per year. Such an effect is consistent with predictions from a simple life-cycle model, in which consumers spend more over their lifetimes in response to higher wealth. However, the stock market is known to play a role as a passive predictor of information. Thus it is also possible that stock prices simply lead aggregate economic activity, without any short-run change in spending induced by changes in wealth. Understanding the response of spending to changes in wealth is important for determining how stock market fluctuations affect the macroeconomy. The question also bears directly on theories of saving behavior, and on the issue of retirement preparedness by today's workers. The experience of the past few years provides an interesting opportunity to revisit this issue. Stock prices increased substantially in the 1990s, with the Standard & Poor's 500 more than doubling from 1994 to 1997 and rising another 44% through 1999. At the same time, stock ownership broadened considerably, mostly through mutual funds and retirement accounts, so that a large number of households likely experienced wealth gains. The increase in wealth might be expected to boost consumer spending and lower the saving rate, and indeed these trends occurred. However, it is hard to separate the influence of the "wealth effect" from other factors that also would have promoted spending, such as strong income growth and favorable labor market conditions. This article presents some new evidence on the response of spending to changes in wealth. The data come from the Michigan Survey Research Center (SRC) Survey of Consumers, an ongoing, nationally representative survey of U.S. households. In interviews conducted between July and September 1997, households owning stock were asked special questions about their spending and saving. The questions covered a number of factors that may influence the effect of wealth on spending, including the value and form of stockholdings, stock price expectations, concerns about retirement, and perceptions of income uncertainty. In brief, the results are broadly consistent with life-cycle saving and a modest wealth effect. The vast majority of stockholders reported no appreciable effect of stock prices on their spending or saving, but many mentioned "retirement saving" in explaining their behavior. The next section reviews previous research on the relationship between stock market wealth and consumer spending. The third section describes the data from the Michigan survey, and the fourth presents the results. A final section summarizes and concludes. II. BACKGROUND AND PREVIOUS RESEARCH To frame the discussion, it is useful to review how an unexpected increase in wealth would affect consumption in a simple lifecycle model. This model, though restrictive in its assumptions, provides valuable intuition about the propensity to consume unexpected stock gains; consequences of refinements to the model are discussed below. …