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Peter Crabb: The real reason the economy remains weak (hint: it's not homes or consumers)

What are you worth?

The United States’ net worth has fallen by trillions, and many see this as the most pressing economic problem of the day.

Policymakers and businesses alike say declining asset values, particularly of homes, are causing consumers to cut back more and more, keeping the economy from growing again.

Testifying before Congress this week, Federal Reserve Board Chairman Ben Bernanke said the Fed expects only “moderate growth” and a “gradual decline in the unemployment rate” over the next several years. Bernanke noted that weakness in housing construction and the job market were holding back consumer spending.

The traditional economic indicators show how bad the recession was, and for some, why it isn’t growing again. Real Gross Domestic Product is lower than it was two years ago. The unemployment rate today is double that of three years ago. Like Bernanke, many commentators see high unemployment as holding back economic growth.

The net worth of the United States isn’t discussed that much. But each quarter the Federal Reserve produces the Flow of Funds report, which includes the “Balance Sheet of Households and Nonprofit Organizations.”

Like a financial statement, this table shows the assets and liabilities of households in the U.S. Household assets are in decline, both the value of homes and retirement portfolios. Unfortunately, household liabilities have not declined at an equal rate.

Since 2007 the value of assets for U.S. households has dropped 13 percent. Meanwhile, total household liabilities have fallen only 2.8 percent.

Yes, most of the decline in asset value is from falling home prices. U.S. household real estate values have fallen 21 percent since 2007. The decline is less serious in Idaho. According to the Federal Housing Finance Agency’s House Price Index, Idaho real estate values peaked in the first quarter of 2008 and have since fallen 14.4 percent.

In sum, the net worth of U.S. households and nonprofit organizations has fallen just over 15 percent since 2007. Net worth peaked in 2007 at $64.4 trillion but is now about $54.5 trillion.

The net worth figure may be important for economic activity because of what economists call the wealth effect. When the value of household assets — such as homes, stocks, and bonds – rises, consumers spend more. Consumers feel better about their future, causing them to spend more today.

Unfortunately, the process can also work in reverse. A drop in asset values may lead to reduced consumer spending.

In the late sixties, 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 rapidly rising stock prices.

Today many attribute the recession to the fall in perhaps the most important household asset: the home. But a more important contributor to this recession, and its high unemployment rate, is the drop in business investment.

Gross Private Domestic Investment has fallen 24 percent since its peak in the second quarter of 2006. But personal consumption expenditures are actually up 11 percent over the same period.

Consumption declined only slightly in the third and fourth quarters of 2008. Disposable income was also down slightly in these two quarters but is now 4.6 percent higher than at the start of the recession.

The wealth effect is weak, if it exists at all.

Don’t blame the U.S. consumer for a weak economy. If policymakers want to see the labor market improve and the economy to grow, they must look for ways to help businesses increase investment.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.

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