The Wealth Effect Essay

3877 words - 16 pages

The Wealth Effect

The "Wealth Effect" refers to the propensity of people to spend more if they have more assets. The premise is that when the value of equities rises so does our wealth and disposable income, thus we feel more comfortable about spending.

The wealth effect has helped power the US economy over 1999 and part of 2000, but what happens to the economy if the market tanks? The Federal Reserve has reported that for every $1 billion in increase in the value of equities, Americans will spend an additional $40 million a year. The wealth effect has become a growing concern because more and more people are investing; furthermore the Federal Reserve has very little direct control over stock prices. The numbers are staggering. Since the end of 1995, household stock holdings have doubled to more than $12 trillion dollars. And, for the first time, equities are the most valuable asset of the typical American household, not the home. When it comes to spending money, consumers take all their financial resources into consideration, from their income to their home. When an asset surges in value for a sustained period of time, such as the stock market in the 1990s, people feel flush and are willing to spend some additional money, perhaps by buying a fancy car or by taking a more expensive vacation. A good number of Wall Street analysts blame the wealth effect for today's negative savings rate.

Declining stock prices affect firms in several ways. First, lower stock prices, especially induced by profit warnings, increase shareholder pressure on managers to cut costs by laying off workers and scaling back investment. Second, the recent correction has put many stock options underwater, and it is unclear to what extent workers will bargain for more cash in place of options and how this might affect payroll costs and inflation. Third, the factors dragging down stock prices typically spur investors to demand higher risk premiums, which boosts the cost of financing business investment. This takes the form of increased spreads of corporate bond and commercial paper interest rates relative to Treasury yields and lower prices for any new stock that any firm dares to offer. Aside from raising the going price of new finance, the increased uncertainty associated with lower stock prices can spook investors so much, that the availability of finance is reduced. Since the fall, this has been manifested in tighter standards for bank loans, a drying up of lower grade corporate bond issuance, increased difficulty in using stock swaps to finance mergers, a dearth of IPOs, and a sharp slowing of venture capital investment.

One source of uncertainty about the stock wealth effect is that we lack enough experience to pinpoint how much the decline of the Nasdaq will impact small business formation by affecting the venture capital market. Venture capitalists live for the day when companies in which they have invested can issue stock on the Nasdaq. At that point, the...

Find Another Essay On The Wealth Effect

Transfer Tax Essay

1830 words - 7 pages the absolute amount of wealth, which will free them from the pressure of work, and the line drawing problem imposing heavy transfer tax rate can be resolved around such level still encouraging people to seek to thrive without any adverse effect on their motivation. Put it differently, starting to impose heavy tax rate for the wealth transferred beyond such amount that will guarantee “financial independence” to the recipient would be an acceptable

Should the Wealthy Give Back to Their Community?

1370 words - 5 pages ) In conclusion, Carnegie may give good advice as to how fortunes may be spent over a life time, but it is ultimately up to the individual on whether to give to a charitable organization or whether it should be hoarded. Morally, it might be right to return wealth to those who helped bring it about, it is unethical to require a person to undergo that course of action. Although it should be expected for this principle to take effect, it must

The Great Gatsby by F. Scott Fitzgerald

1511 words - 6 pages to life through his characters creating a resemblance between Fitzgerald's personal life and the characters he creates. Fitzgerald's early life proved far from difficult because of him growing up and becoming accustomed with the idea of wealth in one's life, which lead him to believe that his life should be "blessed with wealth and his life graced with ease" (Oxford). This had a profound effect on his life as he often viewed

Perception is Everything: A Look into 1980s Culture and Sin City

1948 words - 8 pages . Although, the truth is these women are forced into this unwanted job because of the extreme unequal distribution of wealth. When someone like Roark has such a large portion of a city’s overall wealth, it is very difficult for average citizens to move up in society. The main effect of an unequal distribution of wealth in a society is a negative effect on economic growth which can be caused by people taking advantage of the other’s desire to get ahead

Inequality and Coalitions Size

767 words - 3 pages social position of the economic agents. In the majority of the studies, this variable is the wealth of the persons or his human capital. The problem with this kind of models is that they do not study the effect of the income distribution over the degree of segregation. As a result, they can't answer questions like the following: the size of the coalitions decrease with the degree of wealth inequality? In a society, the size of the coalitions

Small Element, Big Difference: A comparison of Adam Smith and Karl Marx's view on labor in a capitalist society.

1721 words - 7 pages Adam Smith and Karl Marx are both considered few of the most influential giants in social and economical history. When viewing their economical standpoints, it is not difficult to recognize the difference in ideas that they have regarding society. Adam Smith is an advocator for capitalism and the wealth that can be accumulated in it, while Karl Marx critiques on the flaws of capitalism and praises communism that will overthrow the capitalist

DBQ #1 Contrast and compare Nubian and Egyptian societies

520 words - 2 pages The Nubians defined social status according to wealth and power. Those with great wealth became a higher social class. In early China, marked social status was given to the wise and knowledgeable. The rulers of China had connections with the religious aspects of the Chinese culture. In both cultures, the wise and powerful were given great social status, and were able to control the ways of the people.Documents 1, 2, and 6 can all be grouped into

Karl Marx and Andrew Carnegie concerning their ideologies on class tensions.

1808 words - 7 pages Throughout history competition has created bitter tension between social classes. Competition has occurred in every social structure that has existed to this day. Social structure has been the determining factor of competition: in essence the poorer classes have always tried to compete with the wealthier classes to seize their wealth and power; the greater the economical gap between the two opposing classes the fiercer the competition between


934 words - 4 pages . This leads to an increase in interest rate. As interest rate rises, investment spending falls because of the increased cost of borrowing to finance investment. As investment falls, aggregate expenditure (AE) falls, in turn leading to a fall in real GDP (or Y). (Hence we see as P increases, Y decreases.)Reason #2. Real balance effect (also known as real wealth effect or real money balances effect): It operates through consumption. As price level

"Great Expectations" by Charles Dickens

1499 words - 6 pages In the novel "Great Expectations" by Charles Dickens, he uses Pip as his narrator to describe his ideals, opinions, and thoughts. He conveys the idea that wealth leads to isolation, and also that affection and kindness are more important to a person than social class and wealth. Pip is the perfect character to depict these concepts in the way that Pip is kind as a child but faces changes in himself as money and social class get involved and

How the Events of 14th Cent. Led to Renaissance

855 words - 3 pages created higher per capita wealth for some, average peasant wages rose, and slaver's profits were enormous. In turn this higher wealth allowed some to have a more comfortable and leisure life style, setting the foreground for the Renaissance. In economic terms, the Black Death basically increased wealth among the people. Other area's of rebirth from the plague's effect came in the fields of education. The plague attacked people of all classes, however

Similar Essays

The Effect Of The New Deal On Ethnic Women's Wealth

2471 words - 10 pages The Effect of the New Deal on Ethnic Women's Wealth Introduction: New Labour acknowledges that there is a group of people who are excluded from society. This exclusion is described as, “A combination of linked problems…unemployment, discrimination, poor skills, low incomes, poor housing, high crime, bad health and family breakdown” (ODPM, 2004: 7) The New Deal is

Pursuit Of Wealth Essay

820 words - 3 pages paying for wars and other supplies in the American colonies. Many people also were killed during the Revolutionary war. If the government of Britain had not been greedy and pursued wealth in the manner that they went about, most of those things wouldn’t have happened, because the colonists wouldn’t have rebelled. Although, one positive effect of the pursuit of wealth and self-determination of the American colonies included the colonists fighting for

Unequal Distribution Of Wealth Essay

1500 words - 6 pages difficult for the poor to rise above the poverty level, because they are dependent upon what the upper class deems is a fair wage for producing the goods that they make. Governments implement laws to help with the unequal distribution of wealth, but such laws usually simply mask the actual problem. The laws put into effect by governments are also often only slightly effective in helping with the unequal distribution of wealth, because there are many

Wealth Management In The U.K. Essay

2328 words - 9 pages Introduction This report covers several topic areas in wealth management such as what it seeks to achieve, how a wealth management firm is authorised, who may use this service, the alternative options for a client and the macro-economic environment and legislative influences. Wealth management Wealth management is a practice that best describes the combination of personal investment management, finance advice, and financial planning for