The Economy by Peter R. Crabb: Americans are wealthier than in 2007 but don't feel like it

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaJuly 16, 2013 

Peter Crabb

The data say we are as wealthy as we have ever been. Why doesn't it feel that way?

Investors, policymakers and business managers look at two key economic indicators to assess economic conditions since the recession. Real gross domestic product is 3 percent higher than it was in 2007 before the recession. But the number of unemployed, at roughly 11.8 million, is still 63 percent higher.

It is a similar picture at the state level. According to the U.S. Department of Commerce, real total gross product for Idaho is just 1 percent below its 2007 peak. But the unemployment rate is 6.2 percent, compared with only 3.2 percent in the fall of 2007.

A much less cited statistic is the net worth of the United States. Each quarter the Federal Reserve produces the Flow of Funds report, which includes the "Balance Sheet of Households and Nonprofit Organizations."

Like the financial statements of a company or a personal financial report, this table shows the assets and liabilities of households in the U.S. Due primarily to large drops in the value of their homes since 2007, most households have seen their assets decline. But household liabilities have not declined equally.

According to the most recent Fed data, the value of assets for U.S. households dropped 16 percent in 2008 but is now 3.2 percent above the 2007 level. Household real estate values are part of those assets, but they are still 11 percent below their 2007 level - a loss of more than $2.3 trillion. The increase in value is coming from other sources, such as bank deposits, pension accounts, stocks and bonds. Meanwhile, household liabilities have declined only about 6 percent. Altogether, the net worth of households is about 5 percent higher than it was in 2007.

Despite a still-weak labor market, it certainly looks like we are better off.

The net-worth figure is important for a theory of economic activity called the wealth effect. When the value of household assets rise - such as when home values or stock prices rise - it is expected the consumer will spend more. Consumers feel better about their future, causing them to spend more today. Unfortunately, the process also works in reverse. A drop in asset values leads to reduced consumer spending.

For evidence, many turn to the late 1960s, when U.S. consumer spending continued to grow even while disposable income was declining. The surprising growth in consumer spending was later attributed to a wealth effect from a continuing rise in stock prices.

Policymakers, particularly those at the Fed, have said the recession of 2007 to 2009 was due almost entirely to the wealth effect of home-value losses. If true, consumer spending and the economy should be growing strongly today, because home prices have bottomed out and are now rising.

Perhaps a more important contributor to the recession and the still-weak labor market is the drop in business investment. Gross private domestic investment in the U.S. fell 24 percent from its peak in the second quarter of 2006 and is still roughly 9 percent lower. Meanwhile, real personal consumption expenditures are actually up just 6.2 percent over the same period.

If it exists at all, the wealth effect is weak.

Policymakers can't do much for the economy by trying to raise the value of our houses or stock portfolios. Only when businesses are willing to invest more will economic growth pick up.

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prcrabb@nnu.edu

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