Question

Explain the application of the “wealth effect” on consumer spending in the recession of 2008

Answer 1

INTRODUCTION:

The recession in 2008 was linked to the global economy's American banking sector. Although large assets such as property and stocks are growing, customers prefer to invest more. There's an intuitive sense in that the influence of wealth stimulates personal consumption.

HOW THE WEALTH EFFECT WORKS:

The wealth effect represents the psychological effect that rising asset prices, such as those that exist in the bull market, have on customer purchasing habits. The idea of how protection sentiment, referred to as investor trust, is reinforced by large rises in the valuation of stock portfolios. Extra trust leads to higher consumption levels and lower savings levels.

This theory can also be extended to corporations. Companies appear to raise their recruiting and capital spending (CapEx) levels in response to increasing asset prices in a way close to those seen on the business side.

What this means is that economic prosperity can be improved in bull markets — and eroded in bear markets.

SPECIAL CONSIDERATIONS:

At first sight, the idea that the influence of capital stimulates personal consumption makes sense. It is fair to believe that someone sitting on big profits from a house or equity portfolio will be more likely to spit on lavish vacations, luxury vehicles, or other disposable products.

CRITICS:

However, contend that growing asset capital may have a much less effect on consumer spending than other considerations, such as tax, family consumption and job patterns. Why? Why? Since the gain in the valuation of the investor's portfolio does not necessarily amount to higher disposable income.

Initially, the returns on the stock exchange must be deemed unrealized. Unrealized profit is a profit that remains on paper, but that has yet to be sold in exchange for cash. The same is true of rocketing property values.

EXAMPLE OF THE WEALTH EFFECT:

Proponents of the wealth effect may refer to a variety of times where substantial interest rates and tax rises in bull markets have failed to place a cap on consumer spending. The events of 1968 are a prime example.

Taxes have risen by 10%, but consumers have tended to pay more. While disposable income decreased due to additional tax pressures, wealth continued to increase as the stock market continued to expand.