Jun

7

The wealth effect of moves in stock prices relative to consumption needs more detailed study. When I examined the literature 50 years ago, only one or two papers had considered the issue. Now the fake doctor has mentioned it as under examined. I note oats below 200. Copper with a recent 20% decline. And berk near the magical 10000 level, cotton with 10 consecutive days of decline, and oil tipping below 70 bucks as well as the dismal sales of ice cream in Middletown, Delaware as examples of the wealth effect. What academic or consumption analyses or observations can be made to illumine?

Paolo Pezzutti asks:

How does one explain natural gas moving up against the crowd of sell offs? Maybe consumption is not the main factor in price discovery, but rather hedging against oil. How does this influence the real economy and consumers?

Pitt T. Maner offers:

Of possible interest–A recent simulation done for Forbes magazine:

The Underappreciated Impact of Stocks on the Economy

The American consumer is back. Spending by consumers underpins the last two quarters of positive economic output news. (5.6% growth in the fourth quarter of last year; 3.2% in the first quarter of this year.)

Why have consumers apparently stopped taking austerity measures? The most popular explanation–given that job growth and wage increases have been lackluster, and home prices still linger near lows–is what's called the wealth effect. With the stock market (measured by the S&P 500) up 23.5% last year, consumers felt confident enough to finally buy a car or a new wardrobe. (One data point: car sales were up 17% in April from the year before.)

But with the market turning significantly shakier in the last week–the wealth effect could work the other way. We asked Allen Sinai, the prominent economic forecaster, about how important the stock market is to the economic recovery.

"The role of the stock market is underappreciated," he said. And it's not just the wealth effect that ties the two together. There are four ways, Sinai said, that the stock market affects growth. If the market flags this year, so could the broader economy:

1. The wealth effect, as we mentioned

2. Cost-of-capital: Sinai says that when stocks are up, companies can raise the same amount of money by selling fewer shares, which makes it easier to fund expansion.

3. Through financial institutions: A rising market disproportionately makes business better for banks and other large financial institutions, which increases their ability to lend.

4. Taxes: A rising market allows investors to realize capital gains, which means tax revenue and even room for tax cuts.

Sinai ran a simulation for Forbes that shows how the stock market swinging one way or another would affect major economic indicators. A stock swing of 10% would increase or decrease GDP growth by 0.14%–which is significant when you consider that's $58 billion in output that could rise or fall.

A few other examples:

Consumption: A 10% stock market gain would add $78 billion in spending. But a drop would take out $60 billion.

Residential Construction: It could decline by $6.5 billion if there's a 10% correction in the stock market this year.

Realized Capital Gains: Here the effect is the largest. Gains will swing $35 billion up vs. $37.9 down, along with the stock market–explaining a lot about the volatility of these revenue streams for states like New Jersey and California.

A recent paper claiming to use better datasets and stating that tangible wealth trumps financial wealth:

How does household wealth influence consumption? The empirical evidence brought so far by the literature is unclear, mostly because of the low quality of the data more readily available: aggregate data, cross sections and panel datasets lacking important variables all present major shortcomings for a proper analysis of the wealth effect. The aim of our paper is to contribute to the appraisal of the wealth effect using a new, accurate dataset, and employing a proper estimation technique. We perform a pseudo-panel analysis for the USA (1989-2007) combining information from the Consumer Expenditure Survey and the Survey of Consumer Finances. We divide between durables and non durables consumption, and we also investigate the roles of the different components of household wealth, both gross and net. Our estimates indicate that there is a significant tangible wealth effect (between 3 and 6 cents per dollar), confirming the economic importance recognized by some of the previous empirical literature. On the contrary, financial wealth seems to have no significant effects on consumption, even when debt considerations are included in the analysis. In addition, the wealth effect seems to matter more for older households, for which both the house of residence and the rest of the real estate properties positively affect consumption.

Rudolf Hauser adds:

This recent report on VOX by Boston Fed economist Daniel Cooper argues that the extraction of home equity went to consumption to a far lesser extent than some have argued. While I have read the above, I have not yet read the policy paper he wrote at the Boston Fed.

Stefan Jovanovich writes:

The injection of natural gas into oil wells comes not from already collected and stored gas inventory but from the gas in the reservoir that is being produced. It is the gas pressure that allows oil from deep-drilled reservoirs (like the one that blew out in the Gulf) to reach the surface without artificial assist. This gas used to be flared as an unavoidable by-product of oil production.

From Wikipedia :

Oil wells come in many varieties. By produced fluid, there can be wells that produce oil, wells that produce oil and natural gas, or wells that only produce natural gas. Natural gas is almost always a byproduct of producing oil, since the small, light gas carbon chains come out of solution as they undergo pressure reduction from the reservoir to the surface, similar to uncapping a bottle of soda pop where the carbon dioxide effervesces. Unwanted natural gas can be a disposal problem at the well site. If there is not a market for natural gas near the wellhead it is virtually valueless since it must be piped to the end user. Until recently, such unwanted gas was burned off at the wellsite, but due to environmental concerns this practice is becoming less common.[citation needed] Often, unwanted (or 'stranded' gas without a market) gas is pumped back into the reservoir with an 'injection' well for disposal or repressurizing the producing formation.

Check out this link on Natural Gas Production for more info. 


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