Aaaaaaaaaarrrrrrrrrrrrrggggggggghhhhhhhhh! We all know what income is, it’s that thing that gets paid into a bank account every month then used to pay the bills – and long may it continue (he types with fingers crossed thinking of how shaky a peg he’s currently on). Wealth on the other hand is different. To be wealthy is to have a big house, a flash car, oodles of investments and solid gold pants i.e. to have lots of assets that may or may not generate an income, but have some monetary value and are of varying degrees of liquidity i.e. can be eventually sold for cash (crikey has ebay made the world’s wealth more liquid I wonder?). Except most of us aren’t wealthy and what wealth we have primarily consists of the equity in our houses. So when terribly, terribly serious people witter about consumption and the wealth effect, for the most part they’re referring to the influence house prices have on how much we collectively spend. The only problem is it’s a stupid notion at a macro-economic level, hence the initial “Aaaaaaaaaarrrrrrrrrrrrrggggggggghhhhhhhhh!”
It’s stupid for all sorts of reasons like this one; so say house prices go up - remember when that used to happen? - then chances are I need to spend more to buy a house i.e. rising house prices transfer cash from buyers to sellers, who are more likely to be old with a good pension and suspect attitudes towards gender and racial issues. So if you can net off much of the supposed increase in wealth why do people continuously witter on about the “wealth effect” and consumer spending? I’m guessing this is because of two different theories, a “strong” one and a “weak” one.
Starting with the weak one, this is all about confidence and works along the lines of “Daphne! The Daily Mail says our house is now worth 50 grand more than we paid for it, I’ve just clicked on www.sneak-a-peak-at-how-much-your-neighbours-paid-for-their-house-without-asking-them.com and by jove they’re right, I’m feeling so mighty confident, lets buy some extra tins of beans and caviar to celebrate when we do the weekly shop!”
The strong argument is much less wanky. Instead, rising house prices provide more collateral for banks to lend against. Homeowners in turn take out equity release loans/increase their mortgage when their 2 year deal is up to get some serious spondollas to spend on stuff like diamond yachts and shit.
The significance to attach to both arguments is, of course, set in relation to the netting off effect. The strong argument can also be measured using bank lending statistics and in Britain equity release loans just aren’t that important a factor. The other thing of course is that house prices and consumer spending both tend to rise at the same time because they’re influenced by the same factors, which until the credit crunch largely meant the availability of cheap credit. Hence going daft in a shopping centre with 13 0% balance transfer credit cards with mad limits and taking out a 120% mortgages to buy a new build ensuite city centre flat were simply different sides of the same coin.
So given this is all bloody obvious why a wee while back when I phoned into an invite only tele-conference given by a leading investment bank did I hear one of their professional economists witter on about the “wealth-effect”? The long answer is sociological and takes into account individual ignorance, educational failings, vested interests in the production of economic commentary, prejudice and conformity. The short-answer is because they're an ignorant cock.
More depressing though was the new article on the otherwise fab Voxeu.org, wherein taxpayer funded academics disproved the wealth effect at great length. Presumably they’ll be following up this groundbreaking study with a detailed, econometric analysis of the moon’s cheese content. Cock 2x.