Wealth effect


Wealth effect

The wealth effect is an economic term, referring to an increase in spending that accompanies an increase or perceived increase in wealth.

Effect on individuals

The effect would cause changes in the amounts and composition of consumer consumption caused by changes in consumer wealth. People should spend more when one of two things is true: when people actually "are richer" (by objective measurement, for example, a bonus or a pay raise at work, which would be an income effect), or when people perceive themselves to be "richer" (for example, the assessed value of their home increases, or a stock they own has gone up in price recently).

However, according to David Backus, an NYU economist, the wealth effect is not observable in economic data. For example, while the stock market boom in the late 1990s (q.v. dot-com bubble) increased the wealth of Americans, it did not produce a significant change in consumption, and after the crash, consumption did not decrease.cite web
url=http://www.slate.com/id/2193287/
title=Debunking the "Wealth Effect": Declining house prices don't necessarily slow down consumer spending.
first=Christopher
last=Flavelle
publisher=Slate
date=2008-06-10
]

Effect on government

Recent decades' disillusionment with fiscal policy as a macroeconomy management tool and growing concerns over public debt have led some analysts to characterize government borrowing and spending behavior as a "wealth effect." The relative low cost of government borrowing given the equity premium puzzle allows for the decoupling of current government spending from current government taxation. This decoupling means that current taxpayers do not bear the full cost of current government spending. Hence, government taxes can be lowered and spending can be raised independent of each other, removing the cost/benefit analysis discipline that would be enforced on both taxes and spending if they remained fully connected in the present. (See national debt.)

ee also

* Wealth elasticity of demand
* Income elasticity of demand
* Wealth (economics)
* Ricardian equivalence

References

External links

* [http://www.wordspy.com/words/wealtheffect.asp The Wealth Effect]
* [http://www.portfolio.com/views/blogs/odd-numbers/2008/06/17/in-praise-of-the-wealth-effect In Praise of the Wealth Effect]


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