A Primer on the Economics and Time Series Econometrics of Wealth Effects

Abstract

This paper reviews the statistical approach typically applied by macroeconomists to investigate the empirical link between aggregate data on household consumption, income, and wealth. In particular, we focus on studies determining whether and how much changes in net worth, such as those generated by the stock-market boom in the U.S. over the latter 1990s, are responsible for subsequent swings in the growth rate of consumer spending. We show how simple economic theory is used to motivate an econometric strategy that consists of two stages of analysis. First, regressions are used to identify trend movements shared by consumption, income, and wealth over the long run, then deviations of these series from their common long-run trends are used to help forecast consumption growth over the short run. Our discussion highlights the various judgments that researchers must make in the course of implementing this empirical approach, and we detail how specific parameter estimates describing the magnitude of the wealth effect on consumption-and even broad conclusions about its existence-are affected by making alternative choices.

Disaggregate Wealth and Aggregate Consumption: an Investigation of Empirical Relationships for the G7*

“…This is the approach adopted in recent work on the US consumption function by Ludvigson and Steindel (1999) and Davis and Palumbo (2001). The derivation above assumes that non-human wealth is homogeneous, an assumption followed in the bulk of the literature surveyed in Byrne and Davis (2001).…”

“…As a consequence of these developments, a number of recent studies have investigated the properties of total net wealth as a determinant of consumption (see Poterba, 2000;Davis and Palumbo, 2001). However, rather fewer studies have sought to disaggregate wealth and assess whether rises in sub-components of wealth have differential effects on consumption.…”

Forecasting Stock Market Volatility in Central and Eastern European Countries

“…Hall (1978) has argued that lagged stock prices are important in predicting future consumer spending. Other studies also find support for a link between changing equity prices and consumption (see, for example, Campbell, 2000;Kiley, 2000;Davis and Polumbo, 2001;Dynan and Maki, 2001). Stevans (2004) has shown that changes in wealth resulting from unanticipated changes in the value of equity holdings begin a process whereby households alter consumption growth in order to close the gap between actual and target spending.…”

Financial Liberalisation, Consumption and Wealth Effects in Seven Oecd Countries

“…We follow the tradition of empirical work based on the life cycle model, whereby planned consumption is a function of both human and non-human wealth (Deaton, 1992). A recent example is Davis and Palumbo's (2001) study of the United States consumption function, which attempted to determine whether changes in wealth as well as income affect the growth rate of consumer spending. Ludvigson and Steindel (1999) also examined wealth effects in a quarterly loglinear long-run United States consumption relationship and found a common trend and a statistically significant wealth and income effect.…”