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.

##pating and, in some cases, reversing seems likely to play out in durables more generally. over the 25 years preceding the pandemic, durables prices actually declined, with inflation averaging negative 1. 9 percent per year ( figure 5 ). 9 as supply problems have begun to resolve, inflation in durable goods other than autos has now slowed and may be starting to fall. it seems unlikely that durables inflation will continue to contribute importantly over time to overall inflation. we will be looking for evidence that supports or undercuts that expectation. 3. wages we also assess whether wage increases are consistent with 2 percent inflation over time. wage increases are essential to support a rising standard of living and are generally, of course, a welcome development. but if wage increases were to move materially and persistently above the levels of productivity gains and inflation, businesses would likely pass those increases on to customers, a process that could become the sort of “ wage – price spiral ” seen at times in the past. 10 today we see little evidence of wage increases that might threaten excessive inflation ( figure 6 ). broad - based measures of wages that adjust for compositional changes in the labor force, such as the employment declines in used car prices would begin holding down 12 - month inflation once most of the earlier price increases have fallen out of the 12 - month window. the lower inflation in durable goods is probably due to a number factors, including faster productivity growth in durable goods than in services and globalization. if wages rise in line with inflation and labor productivity growth, then real unit labor costs ( or the labor cost of producing one unit of output ) to businesses are constant. wages may grow slower or faster than inflation plus productivity growth for extended periods because of changing structural factors without being reflected in inflation. ultimately, however, persistently rising real unit labor costs will put upward pressure on prices. - 7cost index and the atlanta wage growth tracker, show wages moving up at a pace that appears consistent with our longer - term inflation objective. we will continue to monitor this carefully. 4. longer - term inflation expectations policymakers and analysts generally believe that, as long as longer - term inflation expectations remain anchored, policy can and should look through temporary swings in inflation. our monetary policy framework emphasizes that anchoring longer - term expectations at 2 percent is important for both maximum employment and price stability. we carefully monitor a wide range of indicators of longer - term inflation expectations. these measures today are at levels