NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption

Martin Lettau, Sydney Ludvigson

NBER Working Paper No. 9848
Issued in July 2003
NBER Program(s):   EFG   AP

Both textbook economics and common sense teach us that the value of household wealth should be related to consumer spending. At the same time, movements in asset values often seem disassociated with important movements in consumer spending, as episodes such as the 1987 stock market crash and the contraction in equity values that occurred in the fall of 1998 suggest. An important first step in understanding the consumption-wealth linkage is determining how closely the two variables are actually correlated, and whether there exist important movements in asset values that are not associated with changes in consumption. This paper provides evidence that a surprisingly small fraction of the variation in household net worth is related to variation in aggregate consumer spending. We use empirical techniques that allow us to quantify the relative importance of permanent and transitory innovations in the variation of consumer spending and wealth and find that transitory shocks dominate post-war variation in wealth, while permanent shocks dominate variation in aggregate consumption. Although transitory innovations are found to have little influence on consumer spending, they have long-lasting effects on wealth , exhibiting a half-life of a little over two years. The findings suggest that most macro models which make no allowance for transitory variation in wealth that is orthogonal to consumption are likely to misstate both the timing and magnitude of the consumption-wealth linkage.

download in pdf format
   (555 K)

email paper

This paper is available as PDF (555 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w9848

Published: Lettau, Martin and Sydney C. Ludvigson. "Understanding Trend And Cycle In Asset Values: Reevaluating The Wealth Effect On Consumption," American Economic Review, 2004, v94(1,Mar), 276-299.

Users who downloaded this paper also downloaded these:
Carroll, Otsuka, and Slacalek w12746 How Large Is the Housing Wealth Effect? A New Approach
Campbell and Mankiw Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence
Case, Shiller, and Quigley w8606 Comparing Wealth Effects: The Stock Market Versus the Housing Market
Bernanke and Gertler w7559 Monetary Policy and Asset Price Volatility
Case, Quigley, and Shiller w18667 Wealth Effects Revisited: 1975-2012
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us