Market correction

Abstract: The second half of the 1990s has seen substantial changes in the wealth of American households, primarily owing to movements in the stock market. From mid-1994 to mid1997, the aggregate value of household sector equity holdings (including those owned by nonprofits, mutual funds, and pensions and other fiduciaries) roughly doubled, for a dollar gain of about $5.2 trillion.(1) Since then, stock market values on balance have continued to rise, but there have been massive fluctuations within a wide band; the dollar value of movements within the band--from the low in October 1997 to the recent highs--has been greater than $3.0 trillion.(2) These enormous swings in wealth no doubt have major implications for consumer spending. For this reason, the ability to measure the implications of the swings--that is, to determine their "wealth effect" on consumer resources--has grown in importance with the changing economic environment. In this article, we examine the wealth effect of stock market changes on consumption. Other things equal, an increase in the stock market makes people wealthier. In general, the wealthier people are, the more they spend. Is it possible, then, to quantify these simple truisms and come up with plausible estimates of the extent to which aggregate consumer spending in the 1990s has been supported by increased stock market wealth? Furthermore, how much would a market correction negatively affect future spending? Our answers to these questions are a bit limited. We find, as expected, a positive connection between aggregate wealth changes and aggregate spending. Spending growth in recent years has surely been augmented by market gains, but the effect is found to be rather unstable and hard to pin down. The contemporaneous response of consumption growth to an unexpected change in wealth is uncertain and the response appears very short-lived. Therefore, we conclude that forecasts of future consumption growth are not typically improved by taking changes in existing wealth into account. In the past, uncertainty about both the long-run (or trend) effect of wealth on consumption and the contemporaneous effect was of modest importance. However, in the current economy--where aggregate wealth fluctuations can be very large relative to household income, spending, and GDP--we find that the uncertainty about the size of the wealth effect also adds a considerable amount of uncertainty to one's ability to understand trends ill consumer spending, over and above the difficulty of understanding the forces behind market movements. In the next section, we briefly review changes in household sector spending, saving, and wealth, and highlight the central importance of stock market fluctuations to cyclical movements in the household balance sheet. We then turn to econometric analysis to measure the effect of a change in wealth on consumer spending. We find that a traditional specification of the consumption function gives a fairly erratic estimate of the wealth effect and may even suggest that the effect was rather small in recent years. By refining the specification and estimation of the consumption equation to reflect more rigorously current econometric concerns, we narrow the estimate somewhat, but are still left with some instability in our result. Using a more up-to-date methodology, we first establish that consumption and wealth, along with labor income, share a common trend. When asset values or labor income rises, consumption tends to rise as well, and we assess the magnitude of this boost to consumption by estimating the parameters of the shared trend--the marginal propensities to consume out of wealth and labor income. Our results suggest that these propensities are somewhat unstable over the postwar period. Nevertheless, we conclude that a dollar increase in wealth likely leads to a three-to-four-cent increase in consumption in today's economy, consistent with widely held beliefs about the long-run impact of wealth on consumption. …

Abstract: This paper examines the long-run relation between prices and rents for houses in Amsterdam from 1650 to 2005. We estimate the deviation of house prices from fundamentals and find that these deviations can be persistent and long-lasting. Furthermore, we look at the feedback mechanisms between housing market fundamentals and prices, and find that market correction of the mispricing occurs mainly through prices not rents. This correction back to equilibrium, however, can take decades.

Abstract: This paper examines the long run relation between prices and rents for houses in Amsterdam from 1650 through 2005. We first demonstrate that these series are cointegrated, a necessary condition for studying movements of the rent-price ratio. We then estimate the deviation of house prices from fundamentals and find that these deviations can be persistent and long-lasting. Lastly, we look at the feedback mechanisms between housing market fundamentals and prices, and find that market correction of the mispricing occurs mainly through prices not rents. This correction back to equilibrium, however, can take decades.