The “wealth effect” … err, make that the “drop in wealth effect”

Excerpted from IBD, ” Wealth Connection”, March 13, 2009

Economy: The Federal Reserve last week announced that Americans’ net worth took an $11.2 trillion hit in 2008 — the biggest on record.

Net worth — basically, the value of everything you own minus the debt you took on to buy it — plunged 9% from 2007’s $64.4 trillion to $51.5 trillion last year. In the fourth quarter alone, Americans lost $5.1 trillion in wealth. Both are records.

This is more than just a paper reduction in wealth. Such a big shift affects our behavior, making us less prone to take risks, less able to borrow, less able to spend and more anxious about the economy.

This is known as the “wealth effect.” When wealth rises, we spend more; when it falls, we spend less. For each $1 change in wealth, spending changes by 5 cents or so, economists say.

Across the economy, such impacts can be enormous. An $11.2 trillion drop in national wealth, for instance, translates into a $560 billion drop in spending — about $1,963 for every American.

This is why economists worry about net worth. If we don’t do something about stemming the decline in wealth and encouraging wealth accumulation, our economy will continue to struggle.

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Full article:
http://www.ibdeditorials.com/IBDArticles.aspx?id=321837955855701

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