Question

Between March 2000 and July 2002 the stock market lost almost 3.5 trillion of vaule and yet consumers spending was still high. Why was there no negative wealth effect?

Answer 1

Changes in housing prices and stock prices creates wealth effect. Increase in these prices creates positive wealth effect and decrease in these prices create negative wealth effect.

However, out of these two, change in housing prices create stronger wealth effect than change in stock prices.

Between March 2000 and July 2002 the stock prices have declined substantially. However, during the same period there is also a substantial increase in housing prices.

So, on one hand, decrease in stock prices was creating the negative wealth effect while on the other hand, increase in housing prices is creating positive wealth effect.

Since, change in housing prices create stronger wealth effect than change in stock prices, there was a net positive wealth effect in the economy at that time.

Positive wealth effect leads to increase in consumption.

Therefore, consumer spending was still high at that time.