Falling stocks can hurt the economy

A decline in the stock market is painful for investors, but the aftermath can be a blow to the economy as a whole. A key risk to economic growth in 2019 is that a drop in the stock market could cause people to cut back on spending, which is worrying, given that consumer spending has fueled nearly three-quarters of growth over the past decade. current economic expansion, according to the Bureau of Economic Analysis. “The correction in stock prices, if sustained, will hurt economic growth in 2019,” said Mark Zandi, chief economist at Moody’s Analytics.

Consumer spending has been boosted by what’s known as the wealth effect, an economic yardstick that measures how changes in household wealth affect people’s spending. Given the rise in stocks and house prices, the wealth effect has increased consumer spending, adjusted for inflation, by more than $ 600 billion during this economic expansion, calculates Moody’s.

But the wealth effect can do more damage on the downside than it helps on the upside. Savers for retirement are more sensitive to the threat of insufficient savings than to the possibility that they are saving too much. Investors who save for retirement tend to have a certain savings target each year, and if a drop in equity values ​​drops their retirement portfolios below that level, they are more likely to save more and spend. less.

Typically, when stock values ​​fall, consumers replace 5% of the losses with additional savings. A 10% drop from the September market peak would result in spending cuts of around $ 150 billion, if stock prices were to stay 10% lower for a year. In this case, gross domestic product growth would be reduced by around 0.7 percentage point, and Kiplinger’s forecast of 2.6% growth for 2019 would be revised down to 2% or potentially even less. .

The impact of the recent market turmoil is unclear, as there is a lag between the evolution of asset values ​​and the impact of the wealth effect. The peak of impact usually occurs a year after the change in wealth. And although the Standard & Poor’s 500 stock index has fallen about 10% from last fall’s peak through early December, corrections tend to pick up within a few months. In addition, rising house prices compensate for market losses when it comes to measuring the impact of the wealth effect. A bear market would have a bigger impact, but even then, an increase in government spending in 2019 could cushion the blow to the economy.

Where it would hurt the most

Nonetheless, you can expect the decline in stock prices to lead to a tightening of the purse strings and bigger bank accounts. Spending on non-necessities is reduced the most when consumers increase their savings. Travel tends to suffer first, with cuts in spending on airline tickets and hotels. The least affected categories include everyday consumer products, such as drugs and groceries.

The regions of the country most affected by variations in stock market wealth are the northeast and the Pacific coast. Residents hold a disproportionate share of the wealth of financial markets, and more people in these regions than elsewhere in the United States are employed by the financial services industry, where premiums tend to be a larger share of the wealth. remuneration.


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