The Poverty Effect?

Have you considered the chance that the so-called wealth effect could work in reverse? Given the weakness in stocks this month, and again today, you might want to.

The effect -- a virtuous cycle of rising stock prices buoying the economy, and therefore the market -- has paused for the first time in years. If stocks continue down, the decline may slow consumer buying, companies' capital expenditures and GDP growth. That, to put it mildly, would not be a plus for stock prices.

Economists have taken to thinking about the effect of equity prices on the real economy fairly recently. Investors began to pay attention to the linkage in recent years after it became clear that Fed Chairman Alan Greenspan used it as a measure of financial and monetary conditions that he considered when setting interest-rate policy. Now, we all do.

There is a lot we don't know about the wealth effect. Economists can only estimate its macroeconomic effects. The folks in economic research at Goldman Sachs guess for every $1 decline in total stock-market capitalization, consumption drops 2 cents to 3 cents. Other economists go as high as 7 cents per dollar. And what about the impact of changing stock prices on investment? Analysts at the research boutique International Strategy & Investment say that capital expenditures, which have helped drive the remarkable economic growth in this economic cycle, are definitely bolstered by a rising stock market. But who can say by how much? ...