The Wealth Effect Hypothesis: a Test in the U.S. Economy

Paul Spallino "The Wealth Effect Hypothesis: a Test in the U.S. Economy" 5 1 - Introduction The last decade has seen a very sensible increase in popular participation to stock markets in the United States. From 1994 to 1997 the aggregate value of household sector equity holdings roughly doubled. Economic hypothesis suggests us that the immediate consequence of this phenomenon is that macro-aggregate trends in consumption have become more sensible to stock market performances. The rationale for this is that investments in the stock market can vary the wealth of investors depending on whether the market is "bullish" or "bearish", therefore a change in wealth is very likely to be translated in a change in consumption patterns. Consumption then impacts directly on production. This is the so called "wealth effect". Empirically we can assess that financial markets had in the last 20 years, and especially in the last 5 years, dramatic increases in their value. All main American indexes have risen. Simultaneously we have assisted to an outstanding performance of the U.S.A. economy partly boosted by increases in private spending and consumption. The question now is: "Is there a causality relationship?" This argument is a very current one, it represents one of the main issues actually taken into consideration by the American monetary authorities. It is important to investigate on