The Wealth Effect and Economic Activity

This report begins with an analysis of the impact of the positive �wealth effect� in the 1990s and the impact it had on consumer spending as prices were rising. The report contends that the wealth effect from rising stock prices operated indirectly by raising consumer confidence and more directly through growth in consumer purchasing power. The subsequent fall in stock markets, particularly the Nasdaq, focused attention on the implications of a negative wealth effect stemming from the loss of $2 trillion to $3 trillion in equity wealth from peak levels in early 2000. The report discusses the concept of the wealth effect and how aggregate consumption and savings responded to changes in total equity wealth. Although the empirical evidence is incomplete, estimates suggest that a reduction of equity wealth in the range of $3 trillion has the potential of reducing aggregate spending to the point where the current economic expansion could end.