edward m gramlich : consumption and the wealth effect : the united states and the united kingdom speech by mr edward m. gramlich, member of the board of governors of the us federal reserve system, before the international bond congress, london, u. k., 20 february 2002. * * * besides sharing a common history, language, and legal structure, the united states and the united kingdom have something else in common. in the past few years, both countries have experienced a significant wealth effect - - so significant that understanding the wealth effect has become an important aspect of conducting monetary policy. in the united states, the average ratio of household wealth to disposable income was about 4. 5 from 1970 to 1995. over the next five years, fueled by a modest boom in real estate values and a huge boom in equity values, the wealth - income ratio shot up to more than 6, the highest recorded value in the fifty years for which wealth data are available. since 2000, equity prices have moderated, but the wealth - income ratio is still above 5. perhaps because of that, consumption remained strong throughout the downturn of 2001. the experience has been remarkably similar in the united kingdom. here the wealth - income ratio has averaged about 4. 75 for the past thirty years, and a moderate boom in housing prices and a huge boom in equity values in the late 1990s took the ratio to 6. 5 by mid - 2000. again, the wealth - income ratio has fallen off since that time, but consumption spending was strong throughout 2000 - 01. with numbers like this, it makes sense to probe into the wealth effect more deeply. i begin by summarizing the empirical evidence on the wealth effect, in both the united states and the united kingdom, and then i move on to some theoretical quandaries. getting into theoretical quandaries sounds like a bad idea for a wrap - up speech, but i will try to persuade you that these quandaries are indeed puzzling - - and also fundamental. empirical evidence on household wealth and spending at the aggregate level, the effect of wealth on consumption has been a mainstay of large - scale econometric models for at least thirty years. the econometric model of the u. s. economy used by the federal reserve has included a wealth effect for all this time, one that suggests that an additional dollar of household wealth leads, over time, to a permanent rise in household consumption of about three to five cents.

a prerequisite for adoption of the euro, will also serve to guide prospective member states. the name “ maastricht ” will therefore always be connected with the euro and will forever have a prominent place in the history of europe. when the maastricht treaty was ratified ten years ago, many doubted whether emu would ever amount to more than the solemn words of a treaty or a laudable objective to be reached at some point in the distant future. however, during the 1990s, policy - makers, governments, central bankers and other political and economic agents showed great resolve and determination to ensure that the single currency would become a reality. today, we can look back on a period of more than five years in which the ecb has successfully pursued a stability - oriented single monetary policy serving more than 300 million citizens. and we all have the tangible proof of monetary union in our pockets, following a highly successful cash changeover process, which represents another historic milestone in the process of european integration. with the euro, this network of interrelations and mutual dependencies in europe has undoubtedly reached a new level. when talking about the possible political implications of the euro, there are fundamental questions about the future of europe to be answered, and i hope that my subsequent remarks will provide some interesting insights. can monetary union function properly without some form of political union? is a “ currency without a state ” a viable construct? indeed, the question of whether a single currency requires - or inevitably leads to - a single state is hotly debated. i think that one of the reasons for this confused state of affairs is that “ political union ” is a rather abstract concept. it can mean different things to different people. on the one hand, political union can be broadly understood as a dense network of integrated policies, common rules and established procedures, as a union with strong and active supranational institutions, with common symbols and a common identity. the european union already exhibits many of these features. if, on the other hand, we understand political union as the establishment of an entity that resembles the traditional nation state, the european union may still have some way to go, if indeed this is the direction that europeans want to take. today ’ s union is not a european federation, for example, or a united states of europe, with a constitution and a single executive. the euro marks the achievement of full integration in the monetary field. in purely functional terms, it is therefore an end point,