ECONOMIC PAPERS Vol. 4, No. 2, Nov, 2001 THE BANK OF KOREA Stock Market and Consumption: The Case of Korea Byung-Hwa Kim* and So-Sang Moon** There have been persistent arguments as to whether share prices have an effec on consumption through a wealth effect or just temporally walk ahead of it. In the case of the Korean economy of the 1990s, it is suggested that variations in stock prices caused a wealth effect in that the consumption of hecury goods, which are, for the most part, purchased by high-income groups with large stocks, fluctuates significantly in the wake of changes in share prices. This result supports Mankiw and Zeldes' analysis(1991) that share prices affect the consumption spending through the wealth effect and, yet, is difficult to apply to all countries and periods uniformly being largely dependent on stock holders! propensities and the degree of economic uncertainty. Moreover, empirical analysis of the effect of the stock price fluctuations on the consumer spending, using an error correction model, shows that a volatile stock market makes macroeconomic activities more unstable, where a 10% point increase in the stock prices leads to as much as a 0.6% point increase in privat consumption and, besides, the response happens within 1 to 2 quarters, differing from that in advanced economies, such as the United States. JEL Classification Number: E21 Key words: wealth effect, leading indicator, composition of consumption spending, factor of consumption fluctuation * Chiof economist and Head of Macroeconomics & Quantitative Studies Team, Economie Studies Off the Bank of Koreae-mail: bhkim@bok.or kr) %* Economist, Macroeconomics & Quantitative Studies Team, Economic Studies Office, the Bank of Korea(e-mail; sosang‘@ bok orkr) The authors would like to thank Yang-Woo Kim, Yun-Chul Kim, participants at the seminar and three anonymous referees for their helpful comments and suggestionsStock Market and Consumption: The Case of Korea $9 I. Introduction Korean real economic activity. which had been stagnant since the fourth quarter of 1997, began to recover dramatically from early 1999, Consumer spending also shifted from the steep decline of 11.4% in 1998 to rapid 10.3% growth in 1999. Although it is normal that fluctuations in consumption are much smaller than those in income, the fluctuation range of consumer spending has exceeded that of Gross National Income(GNI) up to the present since the fourth quarter of 1997, when the movements of macroeconomic variables were largely affected by the currency crisis. Besides, the recent volatile movements of consumption spending cannot be accounted for by income fluctuations alone, considering that the growth rate of labor income, the most important determinant of private spending, has been far below that of GNI during the corresponding period. One factor that has caused recent sudden fluctuations in consumption spending is, among other things, "a wealth effect". That is, it can be inferred that the recent consumption variations which exceed the range of fluctuations in incomes are attributable to the wealth effect from rising stock prices(the composite index, which had declined at the end of 1997 by 43.4% relative to the previous year, rebounded sharply at the end of 1998 by 34.4% and soared in 1999 by 87.6%). However, ‘the objection may be raised that the strong positive correlation between stock prices and consumer spending is not caused by the wealth effect but primarily reflects changes in houscholds’ anticipation of future economic activity. This view, which is quite different from the textbook view that stock prices influence consumer spending through a wealth effect, is that stock prices are merely a leading indicator of future economic activities and, therefore, just temporally walk ahead of consumption in the short term. It would be highly meaningful in understanding not only the way in which the stock market has an effect on the economy but the changes in the propensities of houscholds to consume/save as well, to investigate which of the two views has greater explanatory power over the present relationship between share prices and consumption, That is, if consumption responds to variations in stock prices through the wealth cffect in the short rum, then stockholders’ consumption alone will be substantially affected. As a result, the percentage of goods which are in disproportionately large quantities consumed by stockholders will increase, for which reason the pattem of aggregate consumption will change-for instance. In terms of savings, if stockholders and nonstockholders are different in such pattems of savings as savings rate and sources of savings, variations in stock market should change them. On the contrary, if the stock market just serves as a leading indicator, the pattern of aggregate consumption - to say60 ECONOMIC PAPERS Vol. 4, No.2 nothing of savings - should not change at all since movements of stock prices are nothing but a reflection of the firture expenditure schedule not only of stockholders, but also of most consumers. In terms of policy-making, the two views are also strongly differentiated in their implications. If variations in stock values are far from a immediate cause of adjustment of consumption in the short ran, in making a new policy, share price movements will be nothing but one of the various information variables, never able to play a role of a policy target variable at Icast in the short mun. On the other hand, if it is true that stock price fluctuations exert a considerable effect on changes in consumption even in the short run, policy authorities will be required to take stock prices into account in operating policy for the sake of macroeconomic stability as well as financial stability, This paper aims to examine which of two views on the correlation between stock prices and consumer spending has greater explanatory power in the case of Korea in the 1990s and, then, to estimate the time lag and magnitude of the influence of share price fluctuations on consumption spending. For this purpose, Section I observes trends of stock prices and of other related macroeconomic variables, including those of consumption spending, overall as well as by sector and, furthermore, presents an outline of correlations between them. Chapter III aims to investigate the characteristics of the correlation between stock prices and consumer spending, While the orthodox view suggests that stock prices affect consumption through the wealth effect, not a few economists argue that share prices walk just temporally ahead of consumption, putting emphasis on the leading indicator feature of share prices. An empirical analysis of the correlation between stock prices and the ratio of expenditures by individual item to aggregate ones is made with a view to ascertaining which of the two is the more convincing in the Korean economy In Chapter IV, we analyze the causes of variations in aggregate spending, with a focus on the lags and correlation between stock prices and consumer spending, employing an error correction model(ECM). We estimate a regression on the data since the 1980s, at the same time dividing the whole periods into two sub-periods, the 1980s and the 1990s. The reason is that it is most likely that expansion of stock market, along with advances in economic globalization and the opening of capital market, has increased houschold equity holdings so dramatically that the correlation between stock prices and consumption changes structurally relative to the period before the 1990s. In the last chapter, we review the estimation results, draw some implications from them and, lastly, present a subject for future research on correlations between the two variables,Stock Market and Consumption: The Case of Korea 61 II. Recent Trends of Consumption, Income and Stock Prices Consumer spending, which had decreased sharply since the fourth quarter of 1997, began to recover so dramatically that its growth rate was 10.3% in 1999, higher than the 9.0%, GNI growth rate in the same year. It then continued to increase at 10,0 percent in contrast with the low GNI growth rate of 4.2% in the first half year of 2000. The recent increase in consumption has, for the most part, been led by durable goods, classified by item and is concentrated, grouped by purpose, on such selective expenditures!) as those on recreation & culture or communication rather than essential ones, such as those on groceries or medical treatment. Expenditures on durable goods, especially on cars and personal computers, showed a steady 35.1 percent inorease during the first half of 2000 over the same period of the previous year, following a highly 46.3 percent increase in 1999, And expenditures on communication, among those selective ones which had decreased sharply in the [Table 1] Trends of Indexes on GNI and Private Consump Unit annual _average, % 975-81. 19 980.96 1997 1998 1999, 200. 1975-81 1982-88 1989-96 1997 19981999 gh yp 2000.1 GDP growth rate 68 94 T4507 OT 82 GNI growth rate 62 102-73 «22-86 90D consumption growth tz 347879 3S AAO DD. retailed sale growth rate = 82 85) 47 LD. (99 33106 consumption GDP 39.2 387 345 341 S20 SL Sul 50.2 consumption GNI Ll 579546568 household savings rate” «19.8 25.6 BB 94.03. - - Notes: 1) Figures in National Accounts are at constant. 1995 prices 2) (I-consumptioninational disposable income) x 100 Sources: National Accounts, Bank of Korea, "Wholesale and Retail Indes, National Statistics Office. 1) We divided 12 items of consumption expenditures by purpose into essential and selective ones on the basis of the classificatory criterion on the urban family survey by National Statistical Office-expenses on foods, housing, light and water and medical treatment are classified as essential and the others as selective, Meanuhile, classification into essential and selective expenditures according to th elasticity by item is also applied. For details, see Jo, S. Hand H. S. Lim(1995),62 ECONOMIC PAPERS Vol. 4, No.2 foreign exchange crisis, also increased 33.5 percent during 1999 over the previous year and 35.4 percent during the first half of 2000 over the same period of the previous year, In case of expenditures on recreation and culture, the sharp drop in 1998( 416.2%), caused by the foreign exchange crisis, reversed to a dramatic 15.3 percent increase in the next year and also produced a 21.8 percent increase during the first half of 2000, Likewise, spending on clothing, furniture, installation and lodging showed a remarkable recovery, However, essential expenditures which did not decline markedly in the currency crisis, such as those on education, medical treatment and grocery, inereased in a smooth way, rising by no more than 4 percent during the first half of 2000. Imports of consumer goods, which had fallen off sharply in the currency crisis, began to increase rapidly from early 1999 and continually showed a high increase of around 40 percent in 2000 as houschold consumption expanded. The rapid increase in imports of consumer goods was mainly centered on durable goods and selective expenditure items, which had declined sharply in the currency crisis, just as with the increase of the aggregate consumption, Imports of the durables showed a 45.2 percent growth rate at the first half of 2000, compared with the same half of the previous year, primarily centered on jewelry(52.4%), Motorcars and Bicycles (143.8%) and Golf equipment(56,6%). Meanwhile, the ratio of imports of consumer goods to aggregate imports stood at around 8.7 percent during the first half of 2000, a bit lower than the 10 percent or so before the financial crisis. To grasp why aggregate consumption recently increased dramatically, among other things, we will explore the movements of labor income, the most important [Table 2] Growth Rate” and Composition” of Consumption Spendings by Item Unit: annual average, % 2000. first hatt_ 2000-1 1975-81 1982-88 1989-96 1997 19981999 Durables 18.0( 2.9) 24.6( 6.8) 13. 89) 0.9( 7.2) -32.8( 4.7) 46.3( 6.0) 35.10 6.7) 9.06 -) Semisturables 6,003.1) $.5( 9.7) 10.8( 93) -3.1( 8.7) -26.1( 69) 10.5( 7.1) 17.6( 7.2) 11.5¢ -) Nondurables 4452.9) 5.91429) 6.03.1) 2.6(29.3) -9.2030.5) 7,1(30.8). 5.7(29.8) 3.0¢ -) Services 5.6(31.0) 8.7(40.6) 7.4(48.6) 6.6(54.9) -3.2(57.9) 6.6(56.2) 7.1(56.2) 4.5( -) Private ~, 7 Consumption 34 = 78 = 79 35 ld 10310037 Notes: 1) Growth rate is at constant 1995 prices 2) The values in parentheses represent shares in total at current prices, Source: National Accounts, Bank of KoreaStock Market and Consumption: The Case of Korea 63 [Table 3] Growth Rate and Composition of Consumption Spendings by Purpose Unit annual _average, % ‘2000, 5p 2000.1 1975-81 1982-88 1989-96 1997 19981999. rst hal food and 3.9374) 5.1(28.7) 3.6204) 1.3( 157) 8.71163) 6.6(164) 3.61150) 1.8(-) nonalcoholic beverage alcoholic and tobacco $6( 6.7) 3.3( 48) 22 29) 8 24) -4.3( 24) -O8( 24) 48( 20) 3.70) clothing and footwear 4.(10.0) 33( 64) 9.5( 57) 3.1( 5.0)-24( 40) 7.2( 3:9) 203( 4.1) 1250) rental, gas and water 5.2( 86) 4.4(103) 6.5(138) 6.5(169) 0.5(18.6) 5.0(17.2) 4808.1) 4.70) housing equipment 1064 42) 1544 51) 9.2( 60) 0. 54)-282{ 4518 46)1N6( 47) 88 medical treatment ——11.3{ 39) 182( 67) 9.2( 69) 7.2( 20) 4.6 74) 86 7.4) 05( 7.9) 1620) transportation 10.6( 72) 1.6( 99) 10.6121) 3.2(12.7) -21.1(124) 154126) $5123) 3.70) communication 139( 0.5) 20.4 1.3) 28.1( 1.8)32.2( 3.0) -21.3( 3.6) 33.51 4.3) 384 4.7) 14.76) recreation and culture 10.8( 3.8) 18.5( 6.7) 12.6( 86) 2.1( 84) -16.2( 7.5)153( 7.7) 21.8( 81) 15.16) education 65 33) 69 (45) 38( 45) 350 48) -L1( 50) 34 48) 190 4.) 220) food and 14 94) 58 7.) 45( 76) 3.0( 69) 12.9 65) 142( 67) 6( 65) 4.76) Todging service others 9.1( $.0) 18.3( 7.7) 12. 9.5) 4.3(11.7) -6.2(12.2) 3.2(12.2) 11.9(11.9) 7.4(-) private consumption S478 79 3S M3157 Notes: 1) Growth rate is at constant 1995 prices and values in parentheses are shares in total on the basis of current prices 2) Classifying food and nonalcoholic beverages, rent, water and lightings, housing equipment and management and medical treatment as essential and the others as selective Source: National Accounts, Bank of Korea ion of Consumer Goods by Item? Unit annual _average, % 1991-96 1997 __1998 1999 1-6, 2000 7-8, 2000 [Table 4] Import Growth Rate and Comp Import 146 34 381 285 453 357 Consumer Goods 18.9( 9.3) -7.8(10.2) 42.6( 94) 314( 88) 35.2 8.7) 30A( 8.5) Direct Consumer goods 22.4(28.3) -2.0(270) -41.8(283) 55.729) 348G44) 27.7G4.1) Durables 16.4324) -7.5(304) -30.2(285) 43.6(27.2) 45.2029.1) 38.1295) (Motorcars and Bicycles) 68.6( 1.3) -31.6( 26) -92.0( 1.1) 480.0( 0.5) 143.8( 1.0) 93.9 1.2) (ewelry) 23.4 1.2) -15.9( 10) -58.1( 0.8) 98.8 0.8) 524¢ 1.0) 3.1( 1.0) (Golf equipment) 46.6( 04) -0.9( 0.7) -65.3( 0.6) 2121( 0.6) 36.6( 0.7) 18.3( 0.8) ‘Nondurables 35.0283) -538.9(16.7) 50.8(13.7) 73.4(15.9) 54.1(17.6) (Clothing) SL6( 5.2) 61.5 5.2( 6.1) 104.7( 74) OL 8.6) Notes: 1) At current prices, Those in parentheses are composition ratios. Gold is classified as raw material Souree: Customs Servi64 ECONOMIC PAPERS Vol. 4, No.2 source of income, and of capital gains®), another source of income which has no little effect on houschold consumption. Firstly, taking a close look at the trends of GNI, which might be expected to have the most crucial effects on changes in private spending after the foreign exchange crisis, it showed a dramatic 9.0 percent increase in a reaction to the sharp decline in the previous year but was still lower than 10.3 percent, the growth rate of private spending at the same period. Besides that, the growth rate slowed down to 4.2 percent in the first half of 2000, well below the growth rate of private spending(10.0%) at the same period. Meanwhile, houscholds' recent labor incomes are not increasing sharply unlike the income of companies in that the growth rate of returns to employees on the National Accounts, the primary source of houschold income, was only 3.8 percent, much lower than the GNI growth rate during the same year. Houschold current income in the yearly urban family survey by National Statistical Office in 1999 was reported to be growing at no more than 4.2 percent and labor income at just 3.3 percent, as in the National Accounts. The reason why household labor income has recovered slowly since the currency crisis unlike National Gross Income or Gross Domestic Product seems to have been that the number of those in employment, which had [Table 5] Individual Nominal Income Growth Rate ‘Unit: annual_average, % 1976-81. 1982-88 1989-96 1997 1998 1999 20. 2000. Compensation of employees 332 173 17S. 4760 3B - Operating surplus 98 135 1200 «107 OS - - Property income(net) 29 49.0 34.0 - - "203 W3 1 8g gg Unemployment rate 41 37. 426 HR HSS 8G Growth rate of penons in 32-2826 ASL GS employment GNI 62 2-73 869042 - cpp 68 94 74 50-67 107 UD 92 Sources: National Accounts, Bank of Korea, National Statistical Office 2) Most economic textbooks describe private consumption as being primarily determined by houscholds’ labor incomes and by changes in the values of financial assets they own,Stock Market and Consumption: The Case of Korea 65 [Table 6] Salary & Wage Earners' Households Nominal Income Growth Rate Unit annual _average, Y% 1975-81 1982-88 1989-96 1997 1998 1999 Income 29.2 12.7 164 63 66 44 Current income 29.2 125 16.0 62 67 42 Labor income 288 125 16.0 356 62 3 Property income 373 10.0 146 46-190 63 Non-current income 35,7 214 237 o1 45 61 Other incomes 658 188 257 212 66 140 Source: Urban Family Yearly Survey, National Statistical Office(NSO). decreased 5.1 percent in 1998 showed a slight increase of just 1.6 percent and continued to grow by a large 5.4 percent, even though the wage growth rate was a high 11.9 percent in 1999 and 8.8 percent in the first half of 2000, Taking into consideration that during the period from 1999 to the first half of 2000 the household labor income growth rate was far below the private consumption growth rate, we can see clearly that the high consumption growth rate during this period was accounted for by an increase in capital gains, another key source of income or a boost in consumer confidence due to a forecast of increase in income. In practice, the capital gains of households, widely recognized as having a great effect on consumption, showed a dramatic increase during the period 1998~99 owing to a steep rise in equity?) values, a key source of capital gains, during this period. That is, the KOSPI composite index saw an acceleration of its rate of increase from 34.4% in 1998 to 87.6% in 1999 and, likewise, the KOSDAQ index revealed a record shift from a drop of 30.5% in 1998 to a rise of 256.1% in 1999. The mixed index, the weighted average of the above indexes soared by 132.0% in 1999 after it had taken a turn from a 39.6% plunge in 1997 to a 23,0% rebound in 1998. Consequently, it is estimated that valuation gains on houschold-owned equity’) from the record run-up in stock market during the period 1998~99 amounted to around 7 trillion won in 1998 and to around 74 trillion won in 1999.5) 3) According to "Stock"(April 2000) by Korean Stock Exchange, it is estimated that people who own stocks amounted to 7.1% of the population as of 1999, That is, it means that a quarter of the population is investing on stocks on basis of four members per family and the number of investors would be much larger, including the indirect investment through investment companies ete. 4) This paper employed government, government: and foreigners on "Stoc individuals” items as houschold-owned stocks out of the items classified as ntrolled corporates, corporate investors, general corporate bodies, individuals of Korean Stock Exchange, 5) Estimation methods are as follows. evaluation gains on holdings at the end of the last year() household - owned stocks.:* (stock prices stock prices 1)66 ECONOMIC PAPERS Vol. 4, No.2 In addition, the value of real estate, which is held as another means of wealth accumulation apart from stocks by some groups in Korea, also moved very unstably during the period 1997~2000. This is illustrated by the fact that the index of apartment prices, which are supposed to react to economic conditions with the greater sensitivity of all the real estate prices, had fallen 13.6 percent at the end of 1998 from the end of the previous year but rebounded 8.5 percent by the end of 1999 over the end of the previous year, followed by a 1.6 percent run-up in the first half of 2000. [Table 7] Related Indexes on Stock and Housing Values Unit : Over the last month of the previous your, % 1975-81 1982-88 1989-96 1997 1998 1999, 2000. Sep. 9) fist halt 2000 rate of increase in KOSPL LL -365. 13-434 MA 876 19.2 rate of increase in KOSDAQ. - - A835 2561-379 624 rate of increase, in Mixed Indexes! Market value of listed stock on KOSPItillion won) Market value of listed stock on KOSDAQ billion won) Stock Value(GDP” 83 160 41215. oO - - = 396 3.0 1320-283 47.2 2,747 17,317 106,841 70,989 137,799 349,504 259,819 224,943 : = 7,069 7,892 106,281 65,078 47,157 n2 tafe of increase in housing price index” rate of increase in apartment price index” - 17 6047 1G BSG Notes: 1) The index was composed by weighting KOSPI and KOSDAQ by the market values of each market 2) Stock value is on basis of the balance in last month of the year. The values in the parentheses are to divide the summation of market value both of KOSP! and of KOSDAQ into annual GDP. 3) Housing and apartment price indexes have been reported since Jan, 1986, s: National Accounts, BOK. curity, Korea Securities Dealers Association. Housing Finance, Housing & Commercial Bank. Sout evaluation gains on stocks purchased during the current year(B): (houschold-owned stocks, - houschold - owned stocks (stock prices stock prices.)) evaluation gains cn stocks in acquisition during the current. year( B-By/ [1+ (stock prices/stock pricese: -1)*1/2} total evaluation gains ~ evaluation gains on holdings at the end of the last year(A) + evaluation gains ‘on stocks in acquisition during the current year(’)Stock Market and Consumption: The Case of Korea 67 In examining the effect of variations in the stock market on houschold expenditures, [Figure 1] suggests that equity prices and consumption spending are closely correlated and that the former precede the latter. Lag correlation analysis between stock prices and consumption growth in the period since 1990 shows that a rising stock market boosts consumer spending in the contemporaneous or subsequent quarter. [Figure 1] Private Consumption Growth Rate and Stock Indexes (Consumption growth rate, %) (Stock indexes) 15 - 1100 aneumption grawth rate 000 rol, Consumption growth rat [~~ ee > 900 s ( 800 0 700 4 «00 3 | 4 s00 -10 Stock indexes 4 400 “1s 4 4 L 300 1990 1992 1994 1996 1998 2000 [Table 8] Private Consumption Growth Rate and Lag Correlation Coefficient of Income’, Wage” and Stock Value Fluctuations Time lag(quarters) 3 2 -l 0 1 2 3 Stock value, 029 Od? 06S GEMM 030 Private consumption Income, 0.26 O81 095 OI 019 Private consumption Wages, 024 046 0740820782038 Private consumption Notes: 1) GNI, 2) Nominal wages of all industries. Sources: National Accounts, BOR, NSOs' intemet site(www.nso.go.kr)68 ECONOMIC PAPERS Vol. 4, No.2 I. Characteristics of the correlation between stock prices and consumption 1, Issues on the Correlation between Stock Prices and Consumption In the former chapter, we find that stock prices walk ahead of consumption spending and that the two variables are positively correlated. This chapter explores the features of the correlation between the two variables. According to Friedman's permanent income theory and Modigliani’s life-cycle theory, both of which are representative theories explaining consumption, houschold’s consumption is deter- mined by the present value of the anticipated income that it expects to cam in a lifetime and, therefore, it should vary in the short-run as well as in the long-run through the wealth effect in the event that share prices, one of the main sources of asset incomes, change, Most of the empirical tests before the carly 1990s, such as those operated by Friend and Liberman(1975) and Mankiw and Zeldes(1995), have also been supportive of the theoretical view that share price changes affect consumer spending through the wealth effect. Of late, however, more attention is being paid to the view of Morck, Shleifer and Vishney(1990) and Poterba and Samwvick(1995), which stresses the role of stock prices as a passive predictor of information, ic. a leading indicator of economic activities, that share price fluctuations do not have causal effects on short-term changes in consumption spending so much as just temporally walk ahead of diverse macroeconomic variables including consumption, The implication of this view is that it is most likely that the positive correlation between share prices and private consumption growth is merely caused by the role of share prices as a leading indicator of economic activities in that share prices rise and, likewise. households also increase their consumption, anticipating a higher income and a better labor market conditions when the economy is, or is expected to be, in boom. Nevertheless, they do not raise a fundamental objection to the permanent income theory / life-cycle theory on the ground that they agree that in the long rn, houschold consumption will respond to variations in equity values through the wealth effect. Therefore, it can be concluded that the basic difference between two views is just as to how many lags it takes for houschold consumption to respond to variations in equity values. That is, a key issue is whether the wealth effect emerges within a year or in more than a year, admitting that, in the long mun, it should act. It would be highly useful in understanding not only what effects variations in the stock market exert on the macroeconomy but also how the pattems of householdStock Market and Consumption: The Case of Korea 69 consumption and savings change to examine the features of fluctuations in consumer spending according to variations in stock prices. If variations in stock prices change consumer spending through the wealth effect in the short run, stock prices should have effects only on stockholders’ consumption and, thereby, the percentage of the goods which are mostly consumed by high-income groups expected to own large quantities of stocks should increase and the pattem of aggregate consumption also should change. In the case of savings, changes in equity values should also cause changes in the pattern of savings, such as aggregate savings rate and resources for savings if the behavioral pattern of savings is differentiated between high-income and low-income groups. By contrast, if the stock market plays the role of a leading indicator, movements of stock prices cannot be expected to change the pattern of aggregate consumption and savings at all, since they are just reflecting the future expenditure schedules of most consumers, not being limited to stockholders alone. In terms of policy making, the two views are also quite different in their implications. The view that variations in share prices are far from being a causal factor of fluctuations in consumption spending in the short run implies that in deciding a new policy for stability of consumer spending, one of the most essential macroeconomic variables and, furthermore, of the real economy, movements of equity values are nothing but one of the various information variables, never being able to play the role of a target variable at least in the short term. By contrast, if fluctuations in stock prices exert considerable effects on consumption fluctuations even in the short run, the policy authoritics need to take stock prices into account in operating a policy for the sake of macroeconomic as well as financial stability.) Nevertheless, it is not so casy to make clear whether changes in equity values affect consumption through the wealth effect or are simply ahead of a variety of macroeconomic variables, including consumption. That is because fluctuations in consumption expenditures according to changes in stock prices are not decided by cither of the two channels so much as being more likely to be influenced by both of them, This chapter aims to analyze whether the recent volatile movements of consumption spending in Korea are influenced primarily by the wealth effect out of variations in the stock market or are merely temporally led by a leading indicator feature of stock prices without any changes in patterns of spending. ‘The most idealistic way of testing the two views above is to analyze respectively the response of consumption to variations in equity values which cause substantial changes in wealth, such as future dividends and, in turn, to the independent changes which cause little. This method is used in Morck, Schleifer and Vishny(1990)'s 6) However, it is clear that the predictive power of stock market for aggregate consumption is supported both by the view of the wealth effect and of leading indicator of ezonomic activities.70 ECONOMIC PAPERS Vol. 4, No. 2 analysis of the effect of the stock market on investment, However, it is very difficult, in practice, to divide the influences of equity values on consumption into those caused by such changes in wealth as in dividends and those by independent variations which have nothing to do with them. Hence. in order to examine whether variations in stock prices affect consumer spending through the wealth effect or merely act as a leading indicator of the future real economic activity, we can employ two methods: to depend on the houschold survey data and to make an econometric analysis using macroeconomic variables. Conceming the former option of using the household survey data, the most typical houschold survey is the Michigan Survey This survey's data cover whether houscholds own stock or not, if so how large their holdings, how much they increase their consumption according to changes in share prices and whether they change the category of their consumption, We will ‘try several empirical tests on the basis of these data and, thereafter, derive some implications on the linkage between equity values and private consumption, An carly study using the houschold survey data was done by Friend and Liberman (1975), who asserted that stock prices were negatively correlated with savings, using the survey data on consumers’ financial asset holdings during the period 1962-63. Mankiw and Zeldes(1991) maintained that the correlation between the rate of retums from stock and consumption was higher for stockholders than for nonstockholders, using household panel data. Estimating the correlation between consumption and stock prices employing the 1997 Michigan Survey data, Star-McCluer(1998) concluded that the results of the household survey corresponded generally to that of the life-cycle hypothesis and manifested to some extent the presence of the wealth effect on the ground that most stock-holding houscholds other than the supremely wealthy responded that they determine their spending considering their retirement savings, not changes in equity values. In contrast, on the basis of econometric analysis using the Michigan Survey data for the period Oct. 1995 ~ Dee. 1997, Otoo (1999) supported the view that the role of stock prices as a leading indicator is much more robust although it is not so easy to completely deny the conventional view that stock price fluctuations cause changes in consumption expenditures through the wealth effect The other method is to estimate the correlation between houschold consumption and fluctuations in stock prices, using macroeconomic variables, This method is predicated on the fact that if adjustments of consumption which follow stock price fluctuations are, for the most part, caused by the wealth effect, then the responses of expenditures to variations in stock prices will be distinguished between those of stockholders and non-stockholders. An interesting study concemed with this was done by Poterba and Samwick in 1995, who tested whether there was anyStock Market and Consumption: The Case of Korea 71 correlation between variations in share prices and the percentage of sales of deluxe and supreme deluxe cars7) during the period from Jan. 4th 1980 to Feb. 4th 1995. ‘They argued in their literature that the estimation result that the percentage of deluxe car sales is negatively correlated with stock prices and that of supreme deluxe car sales positively correlated but statistically insignificant implied that it was difficult to conclude that share price fluctuations had a wealth effect in the short run. Thus, they argued that their result supported the view that stock prices do not influence private expenditures through a wealth effect so much as serve as a leading indicator of economic activity, Putting all these existing studies undertaken in the United States together, we see that the view that stock prices walk merely temporally ahead of consumption as a leading indicator is also quite convincing although the conventional view cannot be denied that stock price fluctuations cause consumption changes through the wealth effect in the short run. As with the above-mentioned debate in the United States, quite a few numbers of the general public, especially stockholders, suspect that stock prices only precede real economic activity in contrast with the widespread orthodoxy that household expenditures respond to changes in stock prices through a wealth effect. 2. Empirical Analysis ‘This chapter analyzes which of the two functions of the stock prices presented above is the more dominant in the short run, employing macroeconomic data, such as those for consumption.®) If it is true that rising stock prices boost consumption, then the percentage of consumer goods purchased mainly by stockholders increases since stockholders’ spending increases and nonstockholders’ spending remains unchanged. By contrast, if share prices just walk ahead of consumption because of their role as a leading indicator, then no correlation will be found between share prices and the percentage of expenditures by item. For this purpose, among other things, the time-series data on patterns of expenditures of stockholding as well as nonstockholding families, in other words, the percentage of the expenditure of these families on various kinds of consumer goods are required. However, due to the absence of sufficient and relevant statistics, rational assumptions will supplement the data available, if necessary 7) Deluxe cars were defined as those whose selling prices were higher than $25,000 and supreme deluxe cars as 15 kinds of imported deluxe cars such as the BMW series 8) In the case of Korea, the absence of reliable survey data on consumption, stock prives and the income of households has made empi the present, analysis using houschold surveys difficult in practical terms up to72 ECONOMIC PAPERS Vol. 4, No.2 Firstly, the assumption that high-income houscholds own more stocks on average than the others is made on the basis of the statistics of "urban houschold savings survey" announced by BOK annually until 1995, [Table 9] in which the 1995 survey data are presented shows that houscholds tend to increase their sum invested in stocks in geometric progression with the increase in income, seeing that on average households earning more than 3 million won per month owned stocks worth 2.43 million won, while houscholds averaging below a million won income per month own almost no stocks. Although the related surveys have not been done since 1995, the results of recent surveys done by the mass media on an intermittent basis also show that high-income families hold, on average, more stocks than the low-income do, which is similar to the results presented above.” It is also reported in the country where the statistics concerned are gathered, i. ¢, the United States, that houscholds' shareholdings are strikingly positively correlated with their incomes. As for the United States, stockholding is concentrated only on a small part of households and a substantial number of houscholds do not possess stocks at all although the rate of returns on stocks historically has been higher on average than those on other assets. The results of the FRB Survey show that as of 1992 the percentage of households with direct share ownership was only 17.8% and this was still only 374% even when indirect share ownership through pension funds paid for by households were included. In addition, it also shows that stock holding is disproportionately restricted to specific classes than other kinds of asset holdings in that as of the same year 0.5% of highest-income group hold 58.6% of household stockholdings and 36.8% even when including indirect share ownership through pension funds. In the case of Korea, also, only a few houscholds own stocks and only the rich generally appear to own stocks partly because the past earning rates of stockholdings have not been higher than those of other assets and partly because the several crashes in stock market since the 1960s have spread a consciousness that stocks are a highly risky asset. The fact that stockholders are concentrated only on specific classes means that stock price fluctuations change pattems of wealth distribution by income bracket, thus having a impact on the real economy, such as consumption.10) 9) According to the result of census reported in the Jungangilbo on Sep. 21st 2000, the percentage of the stockholding of high-income group was higher than the low-income group. income per month ‘Slockholders nonstockholders below a million won 6.6% 92.3% 1(1.5)-1.5@) million won 7.6%%11.3%) 91 $84(87.5%) over 2 million won 15.6% 84.5% 10) Conceming this, there is a possibility that the effect of the stock market on the real economy’ changes due to the increase of indirect stock investment, ic. mutual fund along with the stock market enlarged.Stock Market and Consumption: The Case of Korea 73 [Table 9] Household Stock Holdings by Income (at 1995 prices) Unit_:_10,000 Won \ Sum of accounts to Peteentage of stockholdings out of Sum of Stock Average income pet month sees fami accounts 10 seats companies (%) holds Less than 60 1 1000 10 Go ~100 B 161 176 100~140 41 785 322 140~180 39 16 4 180~220 16 BA 5 220~260 140 954 260~300 159 93.1 More than 300 285 853 Note: 1) The percentage of households responding that they owned stocks in a survey of ownership of financial assets issued by securities companis(securities deposits, stocks, BMF beneficiary es, government or public bonds, corporate bonds, financial bonds ete.) Sourve: Survey on savings market of urban families, BOK, 1995 The next problem is how to choose items which high-income groups are taken to consume a great deal on average, The expenditure items of urban houscholds by purpose as well as by income group in the urban family survey announced quarterly by the National Statistical Office are rearranged in [Table 10]. The percentage of consumption expenditures of the high-income group is 43% during the period 1990~99, that of the middle-income groups 37% and that of the low-income group 19%, In case of the wealthy, the percentage of expenditures on furniture and housing equipment, clothing and footwear, education, recreation and culture, transport and communication and miscellaneous goods is much higher than that of the total, 43 percent. By contrast, in the case of the low-income group the percentage of expenditures on food and non-alcoholic beverages, health and medical treatment, maintenance, water, electricity and gas is above 19 percent, which is an average. This result shows that the percentage of expenditures of the high-income group on durables, transport and communication, recreation and culture and clothing is markedly higher than those of the low-incomed on the same items. The dis- proportional income growth from income groups would change the percentage of each consumer goods by way of disparities in the percentage of items consumed by income group. That is, if houscholds in general use their capital gains from a rise in stock prices to consume more, then the high-income groups would increase their consumption more than other groups would and, accordingly, the percentage of those items of which they consume more than do other groups would rise.74 ECONOMIC PAPERS Vol. 4, No.2 [Table 10] Patterns of Consumption by Income Group” High-income(H) Middle-income Low-income) H/L Total O4RW.0) 0370000) 01900) 23 1. groceries 0.400 26.1) 0.3929.7) 0.220323) 18 2. maintenance 03833) 03% 36) 025 48) 16 3. water, ga, electricity 034 35) 03% 44) 0.25 54) 15 4. fumiture and equipment O48 5.4) 035( 4.5) O17 43) 29 5. clothing and footwear 0.45( 7.6) 036( 7.2) 0.18( 6.9) 25 6. medical treatment 040 42) 038 46) 02% 52) 18. 7. education 0.46102) 03% 99) OI 24) 8 reoreation & culture 046 5.7) 036 5:1) 148) 27 9. transport and communication — 046( 13.0) 036 120) OA ALA) 27 10, Miscellaneous 0.46( 21.1) 936 19.1) 15179) 27 Notes: 1) OF the 10 groups, the upper 3 sroups were classified as high-income, the next 4 groups as ‘middle-income and the others as low-income. 2) Figures in parentheses are the percentages of goods and services consumed by income group. Souree: Urban family yearly report, NSO. With a view to examining whether the ratio of expenditures on individual items to the total is significantly affected by stock prices in Korea, we fitted the equation below by the Ordinary Least Squares methods. In CH! CH= ct IM Cg! CH) + again SPI;\+ x ahh G1) CH: the total sum of real houschold expenditures SPE Stock Price index Dji=1, 2, 3): seasonal dummy variables 7: lower-case letters representing consumption items by purpose The statistics on consumption expenditures on 12 items in the National Accounts are utilized for estimation, since they are taken not only to be somewhat different from the trends of the statistics on “urban family surveys" by National Statistical Office, which utilized a sample survey, but are assumed to be much more accurate. We regress this model during the period 1990. I~ 2000. II. And since not all the data was seasonally adjusted, seasonal dummies are contained in the model and most of them turn out to be statistically significant.Stock Market and Consumption: The Case of Korea 75 ‘The regression results presented in [Table 11] shows that expenditures on items of which relatively more are consumed by the high-income group have a positive correlation with stock prices while those on items of which high-income groups consume less are negatively correlated with them, In greater detail, stock prices have a positive and statistically significant correlation with the percentage of total expenditure on ‘transport’, ‘communication’ and ‘recreation and culture’, of which the wealthy consume relatively more and they also have a positive correlation, albeit statistically insignificant, with the percentage of expenditure on ‘clothing and footwear’ and ‘housing equipment and management’, On the other hand, stock prices have a negative and statistically negative correlation with the percentage of expenditure on ‘rental’ and ‘water, electricity and gas’ on which the high-income group spends relatively less, and have a negative correlation with that on ‘food and [Table 11] Effects of Stock Prices on the Weighting of Consumption Items @ oa © & & & DW R 1. food and non-alcoholic 003 098-02 D100 0063.) yop beverages (0.25!) G60f) (096) GILT) @8s) (621°) 2, alcoholic beverages AM 02 006-10 O16 4s ggg and tobacco (149) (14767) (0.79) (3.08) G2) sr) > 034087007013 0.05 0.08, 3. clothing and footwear C13) er") CLI) Gor) CoH) G7 2! OT) 4, housing, water, 019 086 006 002.11 010g gas, electricities LIS) 9.90") 209") 1.67) 839") 8.87") 5, equipment & 06 0780080510. 00695 gs home maintenance (212) @4f) 083) (190) BF) (22 PO 6. health 066 071 004017008 010g gg & medical treatment §— (225°) (TI) LON) UL) 3) 437) 2. transport 2 077 O07 OO 00505 ggg (272) (836) 8) 287) Get) LN") % communication 0.08 1.00 0.16 0.02 0.06, 0.07, 26 0,99 (139) (TOT) AT) 092) 239) (282°) oot culture O38, 08905027, aL 06, 9, reretion and cute (3485 pI) (Loe) (20a) (L0H) (136) ED OM OM 093-03 002-0. OL 10, education (158 aber) Coe) as) Gat) ea) 22 088 : Ol 098 002-000-043, 03 11, restaurants and oles C79) Iya) (er) (038) Case) Car) 2 88 12. miscellaneous a 0.97. a 09. O04 0.03. 19 094 (04D) 37) CLI) 6657) GB.) 2.04) Note: 1) Figures in parentheses are t-values. *, ** mean that the estimates are significant at the 10% and 5% significance level, respectively tional Accounts, BOK Securities, Korea Stock Exchange Sources76 ECONOMIC PAPERS Vol. 4, No.2 nonalcoholic beverages’, ‘alcohol and tobacco’, ‘medical treatment’ and ‘education’ though with a low statistical significance. It can be noted that these results support the view that in case of Korea movements in equity prices lead to changes in consumption through the wealth effect!) Nevertheless, it would be somewhat premature to conclude that consumption growth following a rising stock market is attributable to the wealth effect. Movements in equity prices in general tend to walk ahead of economic activities and in a boom, not only the high-income group but the middle and low income groups as well are likely to increase their expenditures ‘on such selective consumption items as ‘recreation and culture’, which correspond, for the most part, to those consumption items of which the high-income group consumes relatively more. In other words, it is possible that in a period when stock prices are rising, houscholds increase their expenditures on selective goods regardless of whether they own stocks. To settle this problem, it is useful to undertake an empirical analysis on the typical luxuries consumed exclusively by the high-income group but seldom by the low-income group. The analysis is done for most of the luxuries whose reliable quarterly time series data are attainable, ic. the sum of imported diamonds, of imported golf equipment and of imported quality clothing,12) expenditures on overseas travel and the number of deluxe motorcars delivered. A quarter lag is used in this analysis, just as in case of the regression of consumption by the 12 items above. A deluxe motorcar is defined in this analysis as one with an engine displacement of more than 2000cc13) however, the imported automobiles are excluded although most of them belong to the superior deluxe class, since the data on the imported cars are reported by amount as against reporting by number the data on domestic cars, thus making it impossible to compute the ratio of the imported cars to the whole. Meanwhile, in the case of large-sized cars, the percentage of the number of large-sized cars delivered out of the total was employed as an explained variable whereas in the case of other imported goods, the percentage of the amount calculated in terms of Won(‘¥’) out of the total consumption expenditures was used as an explained variable. The estimation results are set out in [Table 12]. First, the amount of imported diamonds and of imported quality clothing, the expenditures on overseas travel and the number of large-sized cars delivered are all positively correlated with stock 11) In the equation above, the result estimated with the real Composite index adjusted by the CPI is little different in the coefficient of stock prices from the result using the nominal index. 12) Only the amount imported from developed countries, ie. the EU, the United States and Japan is included, 13) This is the method of classification into deluxe, medium and small in the current auto-administration law, under whose provisions the National Statistical Office reports the related statistics.Stock Market and Consumption: The Case of Korea 77 [Table 12] Effects of Stock Prices on the Percentages of Luxuries Consumption(lag = 1) wa @ 4 ¢ & WR 0.82 0,09 1. ports of diamonds aso’) 93) 2d 065 2 ei dae i, I Oy BE, AM, ly 3 on 3. Sales of lagesized cas? 3B) Gag) > - = 19 059 4. Groen tm exis At) B73) any de) dary Gus) 8 975 5. Inpots of got equimens 12S, 02, A208 013.09 1.9 gay CIT) 472) 60.17) 5) 2.85") 033) ificant at the 10% Notes: 1) Figures es are tvalues. *, ** mean that the estimates are s and. 5% signi level, respectively 2) The amount of quality clothing imported and sales of large-sized cars are for the period since 1995 due to the limited time-series. Souroes: Statistics of Export and Import, Customs Servives, NSOs' intemet site prices and statistically significant as expected. In particular, large-sized cars and quality clothing are, as anticipated, very highly significant statistically and the coefficients on stock prices movements are notably large, being 1.39 and 0.81 respectively. Also, on imports of diamonds and the overseas travel are of positive sign and are statistically significant at the 10% level. In contrast, golf equipment, which was expected to be a luxury item mostly consumed by the high-income group was not estimated to have a significant correlation with the stock prices movements. Putting all these regression results together, the influence of equity prices on expenditures on costly luxuries consumed mostly by the high-income group, who are expected to own relatively more stocks is robust. As a result, it can be concluded that an adjustment of consumption to changes in stock prices is caused by the wealth effect. Meanwhile, the coefficient of overseas travel on changes in stock values increases from 0.28 up to 0.48, and that of the import of quality clothing also increases from 0.81 to 0.90 with high statistical significance, even when the lag is prolonged to four quarters. However, in the other cases, the coefficients do not increase so much and are not so high in statistical significance as to allow the presumption of a response of consumption to a changing stock market, mostly within a extremely short period, that is, 1 to 2 quarters.14) 14) Even where th ‘on the percentage of expenditures on luxuries was fitted using the real stock price indexes, almost the same result emerged as in [Table 12} and [Table 13}78 ECONOMIC PAPERS Vol. 4, No.2 [Table 13] Effects of Stock Prices on the Percentages of Luxuries Consumption(Lags : 1~4) ew om Se hb hk WR 1. Imports of diamonds Garp dae) ass) - = 25 058 2. Imports of qaity loti (a3 nse") one) 626") Gn) as 13080 3, Sas of ges cas?” 388) 8) (Lay 19 062 4, Ovens tel pnts — (4) B38) By Soh tags) cgay 19. 076 ee ee ee ee Notes: 1) and 2) are all the same as for the notes to [Table As scen from these results estimated above, in Korea it is considered that rising stock prices increase the percentage of expenditures on selective and luxury consumption within a year, This is because a run-up in the stock market encourages the stockholding families or high-income ones to increase consumption through the wealth effect and, conversely, does not encourage nonstockholding or low-income families to do so. Therefore, this means that changes in stock prices affect private consumption through the wealth effect rather than only serving as a leading indicator of economic activities, temporally walking ahead of it. The reason why the wealth effect from fluctuations in stock values occurs so strikingly in the short-run as to overwhelm their role as a leading indicator of future economic activities is primarily that Korean stockholders tend to dispose of their capital gains from a rise in equity values in the comparatively short-run. It can be seen that this strong tendency is mainly attributable to the fact that Korean stockholders are more optimistic of a persistent run-up in the stock market than those of other developed countries. Conservative stockholders would not dispose of their capital gains in a short period even when their equity values rise in case of a fall in stock market, Meanwhile, the estimation results for Korea in the 1990s support the view of Mankiw and Zeldes(1991), and Starr-McCluer(1998) that share prices have a causal influence on private consumption through the wealth effect rather than that of Poterba and Samvwick(1995), and Otoo(1999) emphasizing the role as a leading indicator, However, it depends on the countries and periods whether share prices serve as a leading indicator or exert a wealth effect. Therefore, we cannot rule out the possibility that more than one of the views may be true. This is because stock prices have a wealth effect and serve as a leading indicator at the same time and,Stock Market and Consumption: The Case of Korea 79 therefore, it largely depends on the propensity of stockholders, economic uncertainty and differentiation among countries or periods which of the two is more pronounced IV. The Effect of Stock Prices on Consumption The former chapter showed that in Korea stock prices have a direct impact on private consumption through the wealth effect rather than act as the leading indicator even in the short run, This chapter analyze the magnitude and lag of the effect of share prices on private consumption employing the error correction model(ECM). It is well known that if there exists a stationary long-term relationship betwoen the economic variables with trends, that is, a cointegration, then the ECM, including the error term of the long-term equation, will alleviate the specification error. For the purpose of diagnosing the stationarity of the variables which will be contained in the consumption fimction and of the relationships among their level variables, this paper also carries out unit root tests and cointegration tests, on the basis of which the ECM is set up. First, private consumption is established as determined by income, interest rate, share prices and housing prices, which lead to the wealth effect, and inflation rate and unemployment rate as well, which can be said to indicate the degree of future income uncertainty. Unit root tests are then carried out to estimate the stationarity of the time series on real private consumption and such variables expected to affect it as real GNI, the stock price index, nominal interest rate(Market yields of three- year corporate bonds), unemployment rate, housing price index and inflation rate. The analysis is made after 1982, excluding the periods before 1981 when most of the macroeconomic variables, such as prices and interest rate, showed unstable movements, The augmented Dickey-Fuller method is utilized with a quarter lag, whereby seven variables are all estimated to have unit roots and, therefore, to be an unstationary time series.15) We next examine whether there exists a cointegration relationship among these variables by employing the Johansen cointegrating method. This reveals a stationary long-run relationship among private consumption, income, stock price index and real interest rate during 1982.1 - 1999.IV as follows.!© Meanwhile, considering that in Korea real estate, such as housing, has been the 15) See the appendix [Table 1] for the result of unit-root test on these variables. 16) A test using L-max statistic and tr than 3 cointegrating equations, however, the cointegrating equation reported in this paper is judged as the only one corresponding to that theoretically anticipated and, at the same time, economically significant e statistic concludes that there exist no fer80 ECONOMIC PAPERS Vol. 4, No.2 mon; 1.38+0, 861n GNZ,— 0.021In RCT,+0.01 InSPL, (1) CON: real private consumption GNE real gross national income SPE stock price index RCT: trend of the nominal interest rate(RC, 3 year maturity retums on corporate bonds), which is estimated by HP-filtering(adjustment parameter=1800) main source of household capital gains, we contained it in testing cointegration relationship. The housing price index, used as a proxy variable of the prices of real estate, has been published since 1986, so that the cointegration relationship is examined for the period only after 1990, As this reveals, even in the case of containing the housing price index, there also exists a long-run equation haying a stationary relationship to consumption as below, (4-1') InCON, .531n GNI,—0.54 In RCT; (4-1) +0.041InSPI,+0.80In HOUSE; HOUSE: housing price index The estimated cointegration equation shows that the long-term influences of fluctuations in stock prices on consumption have been growing recently, seeing that a 10% increase in stock prices leads to a 0.4% increase in consumption in the 1990s, relative to a 0.1% increase in the 1980s. According to most of the empirical analyses, domestic or abroad, a 10% increase in stock prices leads to a 0.3~0,7% increase in houscholds consumption within a 1 to 3 year lag, albeit these findings differ by researcher and by country Next, an Error Correction Model(ECM) can be set up, which explains the short-run dynamic adjustment process among these variables on the basis of the cointegration equation (4-1). ECM suggested by Engle and Granger(1987) contains din CON; ee bah, 1+ SS endin CON, c+ & asidinGNh« + x eI RCBR i+ 3 as Ainflation. =~ x ag; ANSP + & endin HOUSE, ++ (42) EC: the error term of cointegration equation inflation. the growth rate of consumer price index(CPI) RCB; the real interest rate of RCStock Market and Consumption: The Case of Korea 81 in the regression equation at the same time differentiated variables and level ones, which is equal to the error term of the cointegration equation, ECM, modelling the short-run dynamic relationship, reflecting the above cointegration equation indicating the long-run trends of private consumption, is specified below. The private consumption equation specified above should be divided into three sub-periods 1982~—99, 1990~—99 and 1982~89 in order to examine whether structual changes occurred in the effect of share prices on private consumption from the beginning 1990s as the capital market of Korea, specifically the stock market, advanced a great deal quantitatively as well as qualitatively, including the launch of full-scale market opening, The estimation results are arranged in [Table 14]. We choose the lags of explanatory variables ruling out insignificant lagged variables according to the general to specific method, thereby analyzing the accumulative effects of significant lagged variables. As anticipated, an increase in interest rate is estimated to slow down consumption growth and, likewise, increases in inflation rate to diminish consumption by multiplying uncertainties about future income. The impact of stock prices fluctuations on private consumption shows. statistical significance during the 1990s, whereas it is statistically insignificant during the 1980s. Further, the coefficient for share price fluctuations is 0.06, somewhat larger than in case of foreign countries. This means that a 10% point increase in stock prices will increase the growth rate of private consumption by 0.6% point over the current and next quarter, And the correlation between stock prices and private consumption is, observedly, effective within a short term in that the coefficient does not increase markedly nor is it statistically significant as a result of regression with Jags of 4 quarters including the current. This implies that the volatility of stock [Table 14] Estimation Result of Consumption Function 1982~89 1990 ~99 1982~99 Constant 4,60( 3.10") 0,53(0.84 ) 0,36( 0.81 ) onsumption tl} 0.33(1.16 ) 0.50( 2.76") 0.70 6.68") Alneome 0,07( 0.98 ) 0.40( 1.81") 0.20( 2.00") crest rate 0.2903 ) 0190.18 082-209") PI growth rate 0.20.90 ) 086-402) AStock price index{t, 1} 0.02( 0.70 ) 0.06( 247") ousing price index - - 1530.22) 015001) 0.03(0.00 J R 023 093 085 DW. 20 24 19 Note: *, ** mean that the estimates are significant at the 10% and 5% significance level, respectively.82 ECONOMIC PAPERS Vol. 4, No.2 [Table 15] The Percentage of Household Stock-holdings (in 1999) Stock Value owned by — Gpp — (AYGDP-—(BY(A)—(BYGDP (A) individuals (By (0) (0) (00) Koreatillion won, %)) 473931 150,143 444,367 106.7% 31.7% 33.8% USbillion $, %¥" 166,422 69,521 91,904 181.1% 418% 75.6% Notes: 1) The stock value and stock value owned by individuals are based on data surveyed as of year- end 1999("Stocks, Korea Stock Exchange, April 2000) 2) Intemational Federation of Stock Exchanges. prices may act negatively on the stability of the macrocconomy since, as shown in Chapter III above, the wealth effect of stock price fluctuations on consumption is concentrated much more over the short-medium term in Korea than in the United States, where the wealth effect on consumption fades out only over the long term. Meanwhile, the percentage of stock among houschold asset holdings increased a great deal in the 1990s, That is, the ratio of the total value of listed shares to GDP rose dramatically from 15% in the 1980s to 36% in the 1990s as the opening of ‘the capital market in the 1990s helped the stock market to gorw qualititatively as well as in scale. It is presumed that as a result, the correlation between stock prices and consumption deepened greatly in the 1990s. Besides this, as the result of regressing consumption expenditures as divided into four sub-categories, ic. durables, semi-durables, nondurables and services, changes in stock prices are found to have a statistically significant effect on the consumption of durables and semi-durables while not having a significant effect on that of [Table 16] Estimation Results of Consumption Function by Type (1990. 1 + 4 ~ 1999.4 + 4) Durables Nondurables Services Constant TIWI38) 13X11) onsumption{t-1} 0262.10") 0.64481") Alncome 3 0,19( 2.37") Alnterest rate 0,010.00 ) -,36(-0.28 Alnflation -2.16(-2.49") 2) HASELBT) AStock price indes{t, 1} 0.63( 7.70") 0010.40) 0.05(0.98 Housing price index 1.08243") 0230.80) O41(34T") 0.160 1.23 ) 2770049) 0210.11 7) 8.70048 ) 093 ©7957 92 0.83 27 19 23 23 Note: *, * mean that the estimates are significant at the 10% and 5% significance level, respectively.Stock Market and Consumption: The Case of Korea 83 nondurables and services. It is also estimated that fluctuations in housing prices affect expenditures on durables and nondurables, but do not significantly those on other categories of consumption. Decomposition of the past fluctuations in household consumption by factor [Table 17| shows that they have been determined in the long run by incomes but have been heavily influenced by stock prices and inflation in the short run, More specifically, for the period 1990~99 as a whole, they were determined on average almost entirely by income factors while having been influenced in the course of each year by stock prices, inflation and interest rate. Especially, for 1997~99, around the period of the foreign exchange crisis, when prices and interest rate moved in a highly volatile way, these latter variables exerted a very large influence ‘on household consumption. Meanwhile, we estimate a consumption function, dividing the annual income on ‘the National Accounts into labor income and property income in order to examine whether private consumption is influenced to a different degree by source of income, that is, labor income, property income, transferred income and capital gains. As estimation results, the effect of property income on consumption does not show any statistical significance whereas the effect of compensation of employees(labor income) is statistically significant. Similar results are obtained through the esti- mation by type, such as durables and nondurables.17) {Table 17] Contribution of Consumption Spending by Main Factor’ Unit: % Factor 1990-1996 1997-1999 1998 1999 Income 6.98( 94.2) L14( 78.1) -5.10( $8.7) 5.44 56.6) Interest rate 0,0 03) 0.13 -8.9) 037 3.8) -0.35( -36) Inflation rate 0,07 0.8) 0,90( 61.6) 033% 34) 153 15.9) Stock prices -.07( 0.9) 0.26 17.8) -2.03( 2.9) 248( 25.8) Housing prices OAC -0.71(-48.6) 2.02 20.8) 0.51, Total 7A 1100.0) 3.94100.) -9.71(100.0) 9.61(100.0) Notes: 1) Contributions by factor are obtained by multiplying the growth rates for each factor by the degree of factor elasticitythe estimation results of the consumption function during 1990-99 con [Table 14]) and the contributions of the miscellaneous factors(lagged consumption and constant) are redistributed to the other factors in proportion to their original contributions 2) Figures in parentheses are contribution rates 17) As results of estimating the consumption equation by such source of income as labor income, property income, transferred income and capital gains, using the data of income from the "Urban Households Annual Survey", the compensation of employees(labor income) and property income are found not to be statistically significant in the overall consumption equation, and show even less significance in consumption equation by type84 ECONOMIC PAPERS Vol. 4, No.2 V. Conclusions ‘This paper analyzed the reason that in the Korean economy, private consumption is highly correlated with stock prices and the determinants of private consumption. For this purpose, we began by investigating the movements of related macro- economic variables such as private consumption and stock prices after the currency crisis. Consumer spending, which had plnged sharply from the fourth quarter of 1997, began to recover so rapidly that its growth rate reached 10.3% in 1999 and 10% in the first half of 2000, Expenditures on such durable goods as motor cars and personal computer by type and on merchandise whose consumption is highly income elastic; communication and entertainment by item underwent sudden variation. On the other hand, the growth rate of houschold income, the key determinant of private consumption, was far below that of consumption, in that GNI increased by 9.0% in 1999 and by 4.2% in the first half of 2000 whereas the compensation of employees rose by 3.8% in 1999, Hence, it is presumed that the rapid increase in private spending during the period 1999~the first half of 2000 ‘was attributable not only to income growth but to the wealth effect of the rebound in the stock market or optimism about future economic prospects during the period 1998 ~ 99, ‘According to the conventional theory of the relationship between private consumption and share prices, the former is affected by the latter through the wealth effect. Some economists, however, maintain that share prices do not so much affect ‘the consumption as just precede it at least in the short run, putting strong emphasis on the role of share prices as a leading indicator. We analyzed the correlation between share prices and the ratio of luxuries consumption to the total consumption spending for the purpose of examining which of the two views has greater explanatory power in the case of Korea in the 1990s. It was found that the increase in consumption spending was triggered by a rise in share prices through wealth effect, considering that stock prices were seen to have a marked effect especially on selective spending and luxuries, which are mainly consumed by the high-income group who are expected to hold relatively more stocks. This implies that in the case of Korea, share prices affect the private consumption through the wealth effect rather than preceding it in the role of a leading indicator, Where a change in stock values causes a change in consumer spending even in the short term through the wealth effect, it is stockholder’ expenditure that is mainly affected. As a result, the patter of aggregate consumption will undergo such changes as those in the percentage of goods consumed for the most part by stockholders, that is, the wealthy classes’ consumption increases and changes alsoStock Market and Consumption: The Case of Korea 85 take place in saving patterns such as the savings rate or the means of savings. This result provides policy makers with the implication that in secking to stabilize the real economy as well as the financial market, they should take share prices seriously and not view them merely as an information variable. When estimation results for Korea in the 1990s are compared with existing results elsewhere, the view of Mankiw and Zeldes(1991) and Starr-McCluer(1998) that share prices influence private consumption through a wealth effect is supported rather than that of Poterba and Samwick(1995) and Otoo(1999), which emphasizes the role of share prices as a leading indicator. There might, however, be great differences across countries and periods as to whether share prices play the role of leading indicator or have a wealth effect so that it is premature to judge one view as holding completely good. In other words, it depends on stockholders! propensity and the degree of economic uncertainty which of the two will be the more influential role of stock prices, as both of them are applicable to some extent. Next, we made an empirical analysis of the determinants of private consumption centered on stock prices by employing an error correction model. The results show that the fluctuations in stock prices did not have so much effect during the 1980s as during the 1990s when a 10% point increase in stock prices growth rate was estimated to raise consumption growth rate by 0.6% over the current and next quarters. It is assumed that the rise in the correlation between stock prices and consumption during the 1990s occurred in practice because the ratio of the stock to houscholds-held assets increased dramatically as the acceleration of capital market opening since 1992 encouraged the stock market to develop rapidly in qualitative and quantitative terms. Mcamwhile, inflation diminishes consumption by magnifying the future uncertainty. An increase in interest rate, although the same effect is exercised, does not appear to have an significant effect on consumption. Besides this, in Korea the wealth effect of fluctuations in stock prices on consumption is exerted mainly in the short run, which is very different from the United States where the wealth effect on consumption is dispersed over the long-term. That is why more attention should be paid to avoid the volatility of stock prices having a negative impact on macroeconomic stability In the future, cmpirical studies employing houschold survey data will, por- sumably, contribute to shedding more light on the correlation between stock prices and private consumption. This is because, as the effect of stock prices on private consumption depends largely on the consumption patterns of stockholders, it is desirable to utilize statistics and data which reflect them adequately. As for the subject of study, additional studies on consumption pattem of the propertied and wealthiest group, anticipations of houscholds as to the persistence of stock price86 ECONOMIC PAPERS Vol. 4, No.2 movements or the bequest etc., are desirable to help shed light on the correlation between stock prices and private consumption, References [Un Korean| Choi, C. K. and B. H. Lee, "Effect of Fluctuations in Stock Prices on Consumption," ‘The Bank of Korea, Monthly Bulletin, April 1999. Jo, S. H. and H. S. Lim, "Analysis of Changes in Recent Private Consumption Behaviour," The Bank of Korea, Monthly Bulletin, October 1995. Jo, H. S. and J. S. Bac, "Effect of Rise in Asset Prices on the Economy,” The Bank of Korea, Monthly Bulletin, October 1990. Kim, Y. W., "Time Series Analysis by Johansen Cointegration Test,” Reference Report 92-3, The Bank of Korea Financial Economic Research Center, 1992. [Un English] Boone, Laurence, Claude Giorno and Pete Richardson, "Stock Market Fluctuations and Consumption Behavior : Some Recent Evidence,” OECD Working Papers, No 208, 1998 Carroll, Christopher D., Jefftey C. Fuhrer, and David W. Wilcox, "Does Consumer Sentiment Forecast Household Spending? If so, Why?" American Economic Review, vol. 84(December 1994), pp. 1397-1408. Fricnd, Irwin, and Charles Lieberman, "Short-Run Assot Effects on Houschold Saving and Consumption: The Cross-Section Evidence," American Economic Review, Vol. 65, No. 4(September), pp. 624-33 Hall, Robert E., "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis : Theory and Evidence," Jounal of Political Economy, Vol. 86, No. 6, pp. 971-87. Ludvigson, Sydney and Charles Steindel, "How Important Is the Stock Market Effect on Consumption?," Economic Policy Review, FRB of New York, July 1999, pp. 29-51 Martha Starr-MeCluer, "Stock Market Wealth and Consumer Spending," Working Paper, Federal Reserve Board of Govemors, April 1998. Mankiw, N. Gregory and Stephen P. Zeldes, "The Consumption of StockholdersStock Market and Consumption: The Case of Korea 87 and Nonstockholders." Journal of Financial Economics 29, 1991, pp. 97-112. Morck, Randall, Andrei Schleifer, and Robert W. Vishny, "The Stock Market and Investment: Is the Market a Sideshow?" Brookings Papers on Economic Activity, 2:1990, pp. 157-202. Otoo, Maria, "Consumer Sentiment and the Stock Market," Working Paper, Board of Governors of the Federal Reserve System, November 1997. Poterba, James M. and Andrew A. Samwick, "Stock Ownership Patterns, Stock Market Fluctuations, and Consumption," Brookings Papers on Economic Activity, 2:1995, pp. 295-357.88 ECONOMIC PAPERS Vol. 4, No.2 Results of Unit Root Test and Cointegration Test [Table 1] Result of Unit Root Test InCON (Real Private Consumption) InGNI (Real GNI) InSP! (Stock Price Index) nC (Nominal Interest Rate) InUR (Unemployment Rate) InfOUSE (Housing Price Index) inflation Notes: 1) ADE test model is set up as follows AX= Keir SoaXs ives Values in the table are t-value of 10) 0.01 “1.76 0.19 165" 0.92 18" 0.08 897" 084 “191 The null hypothesis that they have unit roots is rejected in case t-value deviate from the range -2.62~208 sinee the eritical value is -2.62 and 2.08 at 20 level according to the estimator. [Table 2] Result of Cointegration Rank Test Bigenv L-max Trace Har pr L-max0 Trace 0.7939 10898" 174,90" 0 4 18.03 49.92 03802 33.00" 65,92" 1 3 14.09 31.88 0.2460 194s" 32,92" 2 2 1029 1179 0.1769 Bas 13.43" 3 1 7.30 7.30 Notes: 1) Null hypothesis is ri i-0, 1, 2 3.