The wealth effect is what economists call the changes to income and spending that occur when asset values go up or down. In this regard, a key factor behind both the recession and recovery was the sharp decline and now the increase in home values. However, in a dynamic I’ve written about before, these values are not fixed.
Some have argued the wealth effect is asymmetrical–larger going up than coming down, implying a larger boost to growth (and/or a growth bubble) in periods of asset appreciation than a drag on growth when asset values tank. But Samuelson cites a different effect this AM: a weaker wealth effect this time around.
He cites economist Mark Zandi as suggesting that the wealth effect from quick-rising home values during the housing bubble might have been as high as eight cents on the dollar (that’s quite a high estimate) but now is probably only between 2-3 cents.
Like I said, these elasticities change with conditions and sentiments, and of the various factors Samuelson runs through, I suspect loss aversion is the biggest. We may have short economic memories, but I’m sure many of us remember how much our home values fell during the bust, even if we’d paid off our mortgage or had no intention of selling.
It’s as if you were riding a bike too fast, lost control, crashed and badly scraped yourself up. Even once you’re back up and running, you’re like to pedal pretty slowly for awhile.
Update: Dean Baker has an interesting take on this here. He doesn’t address the changing wealth effect that I focus on above, but he shows that given the decline in the real, underlying amount of housing and stock market wealth, we wouldn’t expect consumers to be spending more than they are.