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Credit Suisse - US Economics Digest, Feb 13, 2013

Credit Suisse - US Economics Digest, Feb 13, 2013

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Published by Glenn Viklund

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Published by: Glenn Viklund on Feb 23, 2013
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02/23/2013

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 ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHERIMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com. 
 
CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS
BEYOND INFORMATION
 
Client-Driven Solutions, Insights, and Access
US Economics Digest
US Economics
Honey, I Shrunk the Wealth Effect
In this note, we estimate the changes in consumer spending associated withchanges in disposable income, housing wealth and stock market wealth. Weuse two sample periods, Q1 1993 to Q3 2012 and Q1 1993 to Q2 2007, inorder to investigate whether there is a structural break in wealth effectsfollowing the financial crisis of 2007-2008.
Our study finds that changes in housing wealth have a greater influence onconsumer spending than changes in stock market wealth. This is consistentwith other researchers’ findings.
 
Our most novel finding is that wealth effects appear to have shrunksince the 2007-2008 financial crisis, and more so for housing wealththan for stock market wealth.
One implication of this result is that theFederal Reserve will need to “engineer” even larger bull markets in houseprices and stock prices for any given desired pick-up in economic growth. Thegreat financial crisis is proving to have a long tail.
The potential stimulus to consumption from increasing housing wealth couldbe substantial in the medium term. But given our estimation results, it isunlikely that the improvement in housing this year will spur consumptionenough to fully offset the effect of lower disposable income growth associatedwith the restoration of the payroll tax.
Exhibit 1: Smaller wealth effects after the financial crisis
Elasticity estimates of consumption with respect to wealth*, percentage points
0.0500.0150.0330.0110.0000.0100.0200.0300.0400.0500.060Housing wealthStock market wealthSample period: 1Q93-2Q07Sample period: 1Q93-3Q12
Source: BEA, Federal Reserve, Credit Suisse *Estimated ppt. increase in consumption due to a 1% gain in wealth
13 February 2013
Economics Research
http://www.credit-suisse.com/researchandanalytics
Research Analysts
Neal Soss212 325 3335
neal.soss@credit-suisse.com
Henry Mo212 538 0327
henry.mo@credit-suisse.com
 
13 February 2013US Economics Digest
 
2
 
Honey, I Shrunk the Wealth Effect
 
As the US stock market closes in on new highs and the housing market is clearly onthe mend, there is more and more discussion about whether the ongoing wealthrecovery is having a substantive positive effect on consumer spending.
This isespecially of interest at a time when the payroll tax cut expiration will subtract 1 ppt. fromreal disposable personal income (DPI) growth this year and helps dampen consumer spending.
In this note, we examine the relationships between consumer spending, disposableincome, housing wealth and stock market wealth.
Specifically, we estimate thechanges in consumer spending associated with changes in income and wealth withquarterly data sampling between Q1 1993 and Q3 2012. Consumers feel better (worse) off when their housing or stock market wealth rises (declines). They may be willing to spendmore (less), but their behavior may differ with changes in the two forms of wealth. Additionally, economic and stock market relationships may experience structural shiftsover time. In this regard, we also estimate the model based on a sub-sample periodbetween Q1 1993 and Q2 2007 to investigate whether there is a structural break in wealtheffects following the financial crisis of 2007-2008.
We draw three important observations: (1) the sensitivity of consumption to DPI clearlydominates in both sample periods; (2) the sensitivity of consumption to housingwealth is considerably larger than to stock market wealth in both sample periods; and(3) the sensitivity estimates of consumption to wealth based on the full sample periodare noticeably smaller than those on a sub-sample period before the last financialcrisis, and even more so for housing wealth than for stock market wealth.
It is no surprise to observe DPI’s dominant role in our consumption model estimation, asincome and consumption have moved in tandem over time. The small marginal propensityto consume (MPC) estimate for stock market wealth also helps to explain the modestconsumption growth to date despite recent strong gains in the stock market.
We offer three potential explanations for the somewhat smaller housing wealtheffect following the last financial crisis:
1. Since the housing bubble burst in early 2006, housing wealth volatility has remainedelevated at levels well above its historical norm. Households will be less likely to viewgains in asset prices as permanent, and their willingness to spend will thus berestrained.2. A potential “nonlinear” relationship between consumption and wealth suggests thatincreases in housing wealth that simply restore previous declines would have asmaller effect on consumption than consistent gains like those before house pricesbegan the first sustained slide in living memory in early 2006. The fact that close toone-third of mortgages are still “underwater” or “near-underwater” will only amplify thisnonlinear effect and probably bias our housing wealth effect coefficient estimateupward in the post-2007 subsample period.3. Mortgage equity withdrawals, once the main channel through which consumersgenerated the cash flow to spend beyond their current take-home pay, show no signof recovery following the collapse from 2006-2008. Less cash from monetized homeequity implies less purchasing power and consumer expenditures, and hence asmaller housing wealth effect.
The potential stimulus to consumption from increasing housing wealth could besubstantial in the medium term. But given our estimation results, it is unlikelythat the improvement in the housing market this year will spur consumptiongrowth enough to fully offset offset the effect of lower disposable incomegrowth associated with the restoration of the full payroll tax.
 
13 February 2013US Economics Digest
 
3
 
Wealth effects on consumption: Housing vs. stock market
In assessing the relationship between consumption, income, and wealth, we estimate thechanges in consumer spending that are specifically associated with the changes indisposable personal income, housing and stock market wealth. Our methodology borrowsfrom economists James Stock and Mark Watson’s Dynamic Ordinary Least Squares(DOLS) approach
1
and uses quarterly data sampling between Q1 1993 and Q3 2012.Specifically, we regress the log levels of household spending against log levels of disposable income, housing and stock market wealth. The approach also includes leadsand lags of the first-differenced independent variables to remove correlation betweenindependent variables and error terms and to minimize bias. Additionally, economic and financial relationships may experience structural shifts over time. In this regard, we also estimate the model based on a sub-sample period betweenQ1 1993 and Q2 2007 to investigate whether there is a structural break in wealth effectfollowing the financial crisis of 2007-2008. The breakpoint Q3:07 was selected based onmodel stability diagnostics that we will discuss in detail below.
Exhibit 2: Real DPI vs. consumptionExhibit 3: Household wealth: housing vs. stockmarket
Chained 2005 dollar Chained 2005 dollar 
20,00022,00024,00026,00028,00030,00032,00034,00036,00093959799010305070911
Real disposable personal income per capitaReal personal consumption per capita
 
5,00015,00025,00035,00045,00055,00065,00075,00093959799010305070911
Real housing wealth per capitaReal stock market wealth per capita
 
Source: Bureau of Economic Analysis, Census Bureau, Credit Suisse Source: Federal Reserve, Census Bureau, Credit Suisse
The spending and income data are personal consumption expenditures and disposablepersonal income from national accounts (Exhibit 2). Housing wealth and stock marketwealth data are from Federal Reserve Flow of Funds accounts. Both types of wealth aregross assets at market value ignoring mortgages and other leverage. Housing wealth isdefined as household held real estate assets including land. Stock market wealthcomputed as the sum of corporate equities directly held by the household sector andequity shares in both mutual funds and defined contribution plans held by the householdsector (Exhibit 3). The latest available data on both housing and stock market wealth areQ3:12. Consumption, income and wealth are measured at constant prices in the form of per capita terms, deflated with the consumption expenditures deflator (in chained 2005dollars).Exhibit 4 summarizes the elasticity estimates of consumption with respect to income,housing and stock market wealth. Note that all elasticity estimates are statisticallysignificant in both sample periods.
1
Stock, James and Watson, Mark (1993): “A simple estimator of cointegrating vectors in higher order integrated systems,”
Econometrica
, Vol. 61, No. 4, 783-820.

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