Slumping Stocks Threaten a Pillar of the Economy: Spending by the Wealthy

The recent slump in stocks has sent shockwaves through the financial world, but the implications go far beyond the numbers on a screen. The spending power of the wealthy, a critical pillar of the economy, is now under threat. As stock prices decline, the disposable income of high-net-worth individuals diminishes, potentially leading to a ripple effect that could slow down economic growth.

The relationship between asset prices and consumption is a well-documented phenomenon. Empirical evidence suggests that household consumption is correlated with wealth and does respond to permanent changes in wealth. However, the vast majority of the fluctuations in asset values are attributable to transitory innovations that display no association with consumer spending. This implies that the current slump in stocks may not have a lasting impact on consumer behavior among the wealthy, as they are more likely to be influenced by permanent changes in wealth rather than temporary fluctuations.



The current slump in stocks is driven by several key factors. One significant factor is the dramatic decline in stock values, which has been a recurring theme in economic history. For instance, the stock market decline of the late 1990s did not depress expenditure as expected due to an offsetting real estate wealth effect. During 2000–2001, house prices grew by over 8% a year in the USA and similar rates were recorded in the UK and euro area. This synchronization between house prices and consumption growth suggests that fluctuations in asset values can have a significant impact on consumer spending.

Another factor influencing the current slump in stocks is the correlation between asset prices and consumption. Empirical evidence suggests that household consumption is correlated with wealth and does respond to permanent changes in wealth. However, the vast majority of the fluctuations in asset values are attributable to transitory innovations that display no association with consumer spending. This implies that the current slump in stocks may not have a lasting impact on consumer behavior among the wealthy, as they are more likely to be influenced by permanent changes in wealth rather than temporary fluctuations.

The relationship between asset prices and consumption is also driven by common macro-economic factors. For example, asset prices may respond to future income prospects to which current consumption also responds, provided that households do not suffer borrowing constraints. This suggests that the current slump in stocks may be a symptom of a future slowdown in consumer spending rather than a cause. Additionally, financial market liberalization may drive up asset prices and stimulate consumption by relaxing borrowing constraints, as suggested by Muellbauer and Murphy (1990).

In conclusion, the current slump in stocks is driven by fluctuations in asset values, the correlation between asset prices and consumption, and common macro-economic factors. These factors may influence future economic trends and consumer behavior among the wealthy by affecting their spending patterns and investment decisions. However, it is important to note that the impact of the current slump in stocks on future economic trends and consumer behavior among the wealthy may be mitigated by the offsetting real estate wealth effect and the fact that the vast majority of the fluctuations in asset values are attributable to transitory innovations.