Economists have long recognized a phenomenon known as the “wealth effect.” When “households become richer as a result of a rise in asset values, such as corporate stock prices or home values, they spend more and stimulate the broader economy.” Americans at all income levels experienced the wealth effect during the Trump years. “Bidenomics” has brought the wealth effect to a screeching halt, which is one big reason why President Biden’s polling numbers are so low.
Most people recognize the impact of the wealth effect in their own lives and economic decisions. When people feel wealthier, whether they actually are or not, they are more likely to spend money on discretionary items, such as going out to dinner, traveling or perhaps buying a new car or appliances.
Several factors help create the wealth effect: a rising stock market and home values, a growing economy, and low unemployment, which promotes job security and often wage and salary increases. When these factors are improving, people tend to spend more, which spurs even more economic growth, further enhancing the wealth effect.
On the other hand, when the stock market or other assets are flat or declining, when inflation is high and there is a general malaise about the economy, that situation is referred to as the “reverse wealth effect.” And it too can feed on itself by making consumers more cautious, lowering economic growth and exacerbating public gloom. And we can see those trends under Bidenomics.
The stock market: When Donald Trump entered the White House in January 2017, the Dow Jones Industrial Average was just above 20,000. When he left it was nearly 30,000 — a roughly 50 percent rise in four years. And that was after a huge drop in the spring of 2020 due to COVID-19 and the states shutting down.
After nearly three years of Bidenomics, the Dow closed last Friday at 33,507, an increase of about 10 percent. Worse yet, the Dow was at 33,500 in April of 2021. While there have been some ups and downs, the Dow has essentially moved sidewise for two and a half years. That stagnation helped eliminate any residual wealth effect from the Trump years.
But is the general public really affected by the rise and fall of the stock market? You bet. Gallup data reveal 61 percent of Americans reporting own stock, including both direct investing or through retirement accounts such as a 401(k). Workers and retirees who see their retirement accounts remain flat or sinking feel poorer — and they are.
Inflation: Inflation may be an even bigger factor than the stock market in ending the wealth effect. Inflation erodes purchasing power, reducing the value of any savings or assets. People feel poorer and turn cautious by scaling back spending and consuming, which tends to lower economic growth and encourages even more scaling back.
Home values: CNN reports that home values are starting to rise again, but only after several months of declining values. And that rise in values has more to do with a shortage of supply, not a growing economy.
Moreover, Bankrate announced last week, “Mortgage rates punched through 7.5 percent this week, highest level since November 2000, according to Bankrate’s national survey.” With mortgage rates that high, homes are no longer affordable for millions of Americans, which increases the economic malaise.
Consumer confidence. It’s easy to see the impact of these changes on consumer confidence. The Conference Board just announced its Consumer Confidence Index declined for the second straight month, adding “consumer fears of an impending recession also ticked back up.”
But don’t the Federal Reserve Bank’s interest rate increases share some responsibility for the loss of the wealth effect?
Yes, but the Fed is raising interest rates in an effort to lower inflation. Had Biden not pushed through his misnamed American Rescue Plan in early 2021, pumping hundreds of billions of dollars into people pockets, inflation (and federal debt) would have been lower — as several prominent Democratic economists warned. Without the ARP, we likely would have had lower interest rates and a higher stock market.
Now even Democrats are grousing about the term Bidenomics. But it’s not the name that’s the problem, it’s Biden’s policies. And while there was a solid wealth effect under Trump, some of Trump’s new proposals — e.g., across the board import tariffs and more industrial policies — might preclude a wealth-effect revival.
The wealth effect is a direct result of pro-growth economic policies: low tax rates, limited government and lite-touch regulation. Currently neither major candidate is embracing that approach.
Merrill Matthews is a resident scholar with the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter @MerrillMatthews.