Tuesday, October 27, 2009

The Economic Wealth Effect

2008, saw a precipitous decline in UK wealth. UK wealth fell to £5.8 trillion at the end of 2008. A decline of £844bn or 13%. The decline in wealth was a combination of a £394bn fall in housing wealth and a £450bn

Although, in 2009, house prices have stabilised and stock markets have showed signs of recovery, the outlook still looks bad with wealth expected to decline a further £251bn in 2010.

Whilst these declines in wealth are dramatic, they should also be placed in context of rapidly rising wealth during the long house price boom since the mid 1990s. Rising house prices contributed to growing wealth inequality between property owners and non-property owners. Wealth is still much higher than in the mid 1990s.

Impact of wealth on Economy

Economists generally agree that wealth has at least some impact in influencing consumer spending. For example, rising house prices help to boost consumer spending for two reasons.
  • Householders feel more confident to spend. Saving rates tend to fall because householders view housing equity as a form of saving. It is no coincidence the saving rate has started to rise as house prices have fallen.
  • Equity withdrawal. Rising house prices give households the opportunity to re-mortgage their house and spend the extra money. This source of consumer spending was quite significant up to 2007. See: Graph of Housing Equity withdrawal
The impact of stock market wealth is perhaps less noticeable. Short term fluctuations have limited impact in effecting consumer spending. However, a prolonged, sustained fall does affect income from pension funds and investment trusts. When consumers realise the decline in their pension fund, they start to adjust the spending and may increase their own savings to compensate for lower pension funds.

Changes in wealth do not always directly affect consumer spending. Most households do not tie their spending to the value of their house. For most people a rise in house prices doesn't mean much because they can't access it. Although re-mortgaging is popular, it is only taken up by a minority of households.

Yet, the sustained decline in wealth we have seen since the start of 2008, will effect the economy in 2010 and 2011, lower wealth will lead to higher savings and make a recovery slower. The UK economy may have to look for more diverse sources of economic growth than consumer spending. - And that of course may be no bad thing.

No comments: