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Not All Wealth is Created Equal

Total net worth, or household wealth, has reached a new record high, at least in nominal terms. This has pushed many to argue that Americans have been using the accumulation in net worth to increase consumption. And there is some truth around this idea that Americans have been using increases in wealth to increase consumption.

However, many economists, including us, have conducted research on this topic in the past and, while it is true that households use wealth accumulation to increase consumption, the impact of wealth accumulation on overall consumption is not as strong as many seem to suggest. 1

But before getting into a deeper understanding of what is at stake with wealth we need to touch on some concepts that are second nature for economists but not so much for the general public. Households increase consumption out of what they earn in income. That is, households generate income from work and use this income to buy goods and services. Economists have defined the relationship between income and consumption as the marginal propensity to consume out of income (MPCI ). This MPCI has been estimated at close to 96%-98% at the aggregate level. That is, out of each extra dollar of income we earn we spend close to 96 to 98 cents of that extra dollar of income. Of course, this is the aggregate MPCI , as this measure varies across different income levels. In general, the lower the income of a household, the higher is the MPCI and vice versa.

The marginal propensity to consume out of wealth, MPCW, is somewhat similar from the MPCI concept. That is, the MPCW measures how much of an extra dollar in wealth is used for consumption. The different studies measuring MPCW show that consumption out of each extra dollar of wealth is much smaller than the MPC out of income, MPCI . Estimates put the MPCW close to five cents per extra dollar of wealth. That is, for each extra dollar in wealth, households only consume about five cents of that dollar of extra wealth. This means that consumption goes up, but the overall impact is more muted than when individuals earn income, which is spent almost entirely.

But if we split wealth into housing wealth and non-housing or financial wealth, the story is a bit different. Studies show that the MPCW out of housing wealth is higher than the MPCW out of financial or non-housing wealth. According to estimates, households spend about two cents for each extra dollar earned in financial or non-housing wealth compared to about seven or eight cents out of each extra dollar earned from housing wealth. The reason for this is straight forward: housing wealth is more homogenously held by the population compared to financial wealth. This is because financial wealth tends to be held by those in the higher income segments of the population.

Furthermore, the amount of money that households can get out of increases in housing wealth depends on whether households have access to credit. That is, when credit is plentiful and easily available, i.e., low interest rates, households tend to be more willing to borrow and spend out of housing wealth. At the same time, when interest rates are lower and credit is more accessible, financial institutions are more willing to increase lending, as we saw during the period before the Great Recession. But today’s credit environment, i.e., high interest rates, is not conducive to higher household borrowing to access housing wealth and increase consumption from housing wealth. As the graph below shows, HELOC debt as a % of total debt has remained very low during this cycle compared to what happened before the Great Recession.

Although the recent increase in home prices as well as in stock valuations means that Americans have more resources to complement their incomes, there is no evidence that households are digging into their home equity to help them increase consumption. This means that probably the only ones benefiting from higher wealth today in terms of consumption are those in the higher income levels, which have seen a large increase in stock prices. However, those higher income households tend to increase consumption the least out of each extra dollar of wealth.

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1 For example, see “Housing Wealth and Consumption: Evidence from Geographically Linked Microdata,” by Aditya Aladangady, American Economic Review 2017, 107(11): 3415-3446 and “Housing Wealth and Consumption,” by Matteo Iacoviello, Board of Governors of the Federal Reserve System, International Finance Discussion Papers, Number 1027, August 2011


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