The variable impact of wealth effects

Email a Friend

All fields are compulsory

Your name:
Your email:

To include more than one recipient, please separate each email address with a semi-colon ';'

Recipient email(s):

Email yourself a copy?
Comments:

Add Your Comment

All comments are subject to editorial review.
All fields are compulsory

Your name:
Your email:
(will not appear)

You may email your comment to a friend
To include more than one recipient, please separate each email address with a semi-colon ';'

Recipient email(s):

Publish your name?
Receive email notification of new comments posted by other users?
Email yourself a copy?

Comments:

I have read and agree to the Terms and Conditions

First the tech stock collapse and now the September 11 terrorist attacks have produced cataclysmic shifts in the financial landscape.
Both look set to affect major economies for some time. But which will be more damaging? These two shocks are likely to have very different impacts from country to country, if experience from the 1990s is any guide.
Hali Edison and Torsten Sløk, two IMF economists, have been hard at work on research that throws light on this question. One of their papers - Wealth effects and the new economy (IMF Working Paper 01/77) - concludes that the moves of broad stock market indices affect retail sales most in the US and the UK, in percentage terms, and least in Germany, of four OECD countries studied. Japan falls about halfway in between.
The great and the good have been putting these issues under the microscope, very much in tune with the times. Stock market capitalizations tripled as a share of income in most G7 countries, except Japan, between 1994 and last year. So the impact of stock market moves on the total economy has become larger than ever.

"There can be little doubt that sizeable swings in the market values of business and household assets have created important challenges for policymakers," Federal Reserve chairman Alan Greenspan told the Federal Reserve Bank of Kansas City's annual symposium in Jackson Hole, Wyoming, at the end of August. "It is clear that the massive increase in capital values over the past five years had a profound impact on output and income. The influence of capital gains on economic behaviour also is likely to be of substantial consequence for the prospective performance of the economy."



TMT: Americans saw the risk

Dean Maki, an economist with Putnam Investments in Boston, estimates that lower share prices would shave as much as 2% off annualized consumer spending growth in the US during the rest of 2001 if the market were to maintain the losses incurred during the first week of trading following the September 11 attacks. The sell-off, in terms of when the damage might show up, appears to be no different from other major declines in the market. "It would have a significant impact," Maki points out based on his forecasting models, "most immediately during the fourth quarter and then slowly diminishing over the next two or three years."
But there's a bigger impact in the US, the UK and Canada because households in Anglo-Saxon cultures have a longer history of owning stocks and stock markets are larger relative to the total economy. Half of the adult population in the US owned stocks as of last year compared with about 12% in France, for example.
Pension systems featuring personal investment accounts, particularly 401(k) plans in the US, also send immediate signals to consumers about the link between stock prices and personal wealth. Bank-dominated financial systems in continental Europe and Japan as well as pension schemes that give large institutions the job of choosing investments tend to hide these changes.
But broad stock market indices sometimes don't tell the whole story because technology, media and telecom (TMT) stocks, it seems, can be such a different kettle of fish. "Consumers in the US knew that TMT stocks were risky," says Edison. "So, they didn't adjust their spending by as much to changes in TMT stock prices."
By contrast, TMT share prices had more of an effect on consumption in Europe compared with stocks in general. Or to put it another way, TMT stocks had about the same effect on consumption in North America, the UK and continental Europe. But why?
Edison and Sløk think that one reason could be that TMT companies around the world tend to rely heavily on stock options as incentive pay. That's still the case, even in the aftermath of the internet bubble. "You'd expect to see about 22% of the total shares allocated to their option plan at the typical mid-sized technology firm," says Steve Patchel, a compensation consultant with Watson Wyatt in Santa Clara, California. "What's different now is that employees aren't as willing to trade cash compensation for options."
As for the old economy, stock options are more common in US compensation schemes than elsewhere. Ira Kay, the practice leader at Watson Wyatt in New York, estimates that stock options accounted for unmeasured income of about 2% of payroll at America's publicly traded companies, during the late 1990s.
And what is known as the overhang - the proportion of corporate shares either in the company's stock option plan or already granted, but not exercised - continues to rise.
Unfortunately, options granted during the past three years, in most cases trade for less than the exercise price. "I'm very worried about that," says Kay. "People have had substantial cuts in income and there's going to be a dramatic impact on what they spend."
Consumers, of course, aren't the only ones in the driver's seat when it comes to setting the pace for the economy. Management also has a big say when they decide whether or not to invest in new plant and equipment. This flows from a neat indicator called Tobin's "q" - the ratio of the stock market's valuation of existing capital to the cost of acquiring new capital. James Tobin, a Nobel laureate from Yale, pointed out that companies will invest in more new plant and equipment as "q" goes up.
The "q" for TMT companies rose with a vengeance in the 1990s as share prices exploded and the cost of IT equipment plunged. But that was then. Today there's vast amounts of newly installed capacity in the US for broadband and other hi-tech services, with little demand for it in sight. The outlook is also anaemic for investment spending by US companies in most other industries.
It can matter for private investment whether or not share prices move for old-economy firms compared with TMT firms, as Edison and Sløk found in a second paper - New economy stock valuations and investment in the 1990s (IMF Working Paper 01/78). Investment activity reacted more strongly to changes in non-TMT stock prices in North America and the UK compared with continental Europe where managers generally tend to be less responsive to the stock market.
Page 1 of 2 Next | Single Page

The US treasury market reaches breaking point

No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us

The variable impact of wealth effects

Email a Friend

Add Your Comment

US treasury market reaches breaking point

Top 10 financial definitions that are funnier since the credit crunch

Top 10 reasons to tell your boss you deserve a bonus this year

Nomura’s great leap forward: Will Lehman takeover help fulfil its global ambitions?

Eksportfinans turns to government for funding

Why Hank Paulson has failed as Treasury secretary

Middle East real estate debate: Middle East real estate holds its own in unsteady global markets

Plans Look To The New Frontier

Country risk September 2008: Money talks in a world of risk

US treasury market reaches breaking point

Nomura Eyeing Lehman Bonus Renegotiation

Nomura’s great leap forward: Will Lehman takeover help fulfil its global ambitions?

Corporate defaults: The LBO zombies set to stalk the market

Real estate: Global volumes slump in 2008, hangover predicted for 2009

Latest Issue