Hoping to get a better fix on how household wealth affects consumption, the Federal Reserve is trying to sort out the ways in which different assets -- stocks or homes, for example -- affect consumer spending, Alan Greenspan, the Fed's chairman, said on Friday.
A rule of thumb used by many economists holds that for every US$1 increase in a household's wealth, the members of that household increase their spending by US$0.3 to US$0.5 cents. The Fed has found, however, that when a home is sold, the seller's consumer spending goes up by US$0.10 to US$0.15 cents for every US$1 of capital gain, Greenspan said.
Such information is helpful in planning interest rate policy at a time when household wealth invested in stocks is shrinking while home values are rising. "In such circumstances, differences in the propensities to consume out of the capital gains and losses on different types of assets could have significant implications for aggregate demand," Greenspan said.
Greenspan spoke at the opening session of the Fed's annual symposium in this mountain resort, a gathering, organized by the Federal Reserve Bank of Kansas City, that draws most of the Fed's policy-makers. Economists from Wall Street and academia also attended, along with a few foreign officials. It was Greenspan's first public appearance since the Fed cut interest rates last week by one-quarter of a percentage point -- its seventh reduction of the year in an effort to revive the weak economy.
Rather than discuss Fed policy and the slowdown -- a topic that could stir up the markets -- Greenspan devoted his 20-minute speech to a neutral discussion of the Fed's efforts to sort out the wealth effect and its effect on spending. The Fed's seven interest rate cuts this year have been aimed in large part at encouraging consumers to spend and at sustaining home construction and home prices.
Because "consumer spending has amounted to 90 percent of income, it might appear that income is largely sufficient to explain consumption," Greenspan said. But the Fed's studies tell a different story. "Wealth by itself now appears to explain about one-fifth of the total level of consumer outlays," the chairman said.
Although dollar for dollar, capital gains on home sales appear to have a more powerful effect on spending than rising stock market wealth, the latter in the end plays a bigger role because of the huge scope of equity holdings, Greenspan said. "Household capital gains on directly held equities and mutual funds in recent years have been two to four times the size of overall gains on homes," he said.
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