Remarks by Chairman Alan Greenspan Opening remarks At a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming August 31, 2001 |
The rapid technological innovation that spurred the advancement of the
"information economy" has resulted in some dramatic capital gains and
losses in equity markets in recent years. These remarkable developments
have attracted considerable attention from economists and from
macroeconomic policymakers. At the same time, movements in the prices of
some other assets in the economy--changes in house prices, for
example--have been steadier, less dramatic, but perhaps no less
significant.
There can be little doubt that sizable swings in the market values
of business and household assets have created important challenges for
policymakers. After having been relatively stable for a number of decades,
the aggregate ratio of household net worth to income rose steeply over the
second half of the 1990s and reached an unprecedented level by early last
year. That ratio has subsequently retraced some of its earlier gains.
But we must ask whether the aggregate ratio of net worth to income
is a sufficient statistic for summarizing the effect of capital gains on
economic behavior or, alternatively, whether the distribution of capital
gains across assets and the manner in which those gains are realized also
are significant determinants of spending. To answer these questions, we
need far more information than we currently possess about the nature and
the sources of capital gains and the interaction of these gains with
credit markets and consumer behavior.
Analysts have long factored changing asset values into models that
seek to explain consumption and investment. Indeed, in recent years,
household wealth variables have become increasingly important
quantitatively in endeavors to track consumer spending. The importance of
household balance sheet variables for explaining consumption and the
possibility that not all these variables influence spending identically
suggest the need for greater disaggregation than is typically employed in
most models.
Observing that, over the past half century, consumer spending has
amounted to about 90 percent of income, it might appear that income is
largely sufficient to explain consumption. However, econometric evidence
suggests that such numbers may be deceptive. Wealth by itself now appears
to explain about one-fifth of the total level of consumer outlays,
according to the Board's large-scale econometric model, leaving disposable
income and other factors to explain only four-fifths of consumption.
Indeed, if capital gains have any effect on consumption, the
propensity of households to spend out of income must be less, possibly
much less, than 90 percent.
If income and wealth moved tightly together over time, the
distinction between them might not be meaningful for predicting the future
path of consumption. And, over very long periods of time, capital gains on
physical assets are not independent of the trends in disposable income.
But the relationship of wealth to income is demonstrably not stable over
time spans relevant for the conduct of policy. As a consequence, a
statistical system that augments income as a determinant of consumer
spending with information about wealth can significantly assist our
understanding of this key economic relationship.
Conventional regression analysis suggests that a permanent
one-dollar increase in the level of household wealth raises the annual
level of personal consumption expenditures approximately 3 to 5 cents
after due consideration of lags. Arguably, it would not be important to
draw distinctions among various types of wealth if all assets were
engendering similar rates of capital gains. Owing to collinearity in such
instances, all wealth proxies would produce similar estimates of overall
wealth effects on consumer spending.
At times, however, the rates of change in key asset prices have
diverged. For example, over the past year and a half, home values have
appreciated, whereas equity values have contracted significantly. In such
circumstances, differences in the propensities to consume out of the
capital gains and losses on different types of assets could have
significant implications for aggregate demand.
Assuming that the underlying propensities are, in fact, stable and
given enough time-series data with sufficient variation, standard
regression procedures should be able to extract reasonably robust
estimates of any differential in spending propensities--for example, out
of stock market wealth and home wealth. But, in practice, these
circumstances do not prevail. As a consequence, we at the Federal Reserve
Board are in the process of developing balance-sheet disaggregations that
should help us infer the propensities to spend out of capital gains across
different classes of assets.
In carrying out this analysis, we have been especially mindful of
the possibility that the amount by which a capital gain affects spending
may well be a function of whether or not the gain has been realized. On
the buyer's side, when an asset is transferred, the acquisition cost is
its new book value and, by definition, its market value. On the seller's
side, the proceeds from the sale are available for asset accumulation,
debt repayment, and consumption. In this way, a capital gain is realized
and made liquid, with the potential to affect spending, assets, or debt.
The capital gain in the process disappears as an element in the
householder's balance sheet.
Unrealized gains, to be sure, can be borrowed against, and the
proceeds of the loan can be spent or used for repayment of other debt.
Alternatively, the unrealized gain could induce households to finance
additional outlays by selling other assets or by reducing their saving out
of current income. But unless, or until, this gain is realized or is
extinguished by a fall in market price, it will remain on the asset side
of the householder's balance sheet, exposed to price change and
uncertainty.
Equity extraction through realized gains creates liquid funds with
certain value. Indeed, a significant proportion of sellers do not purchase
another home. In contrast, extraction of unrealized gains does not reduce
the householders' uncertainty about their net worth or their exposure to
market price changes. This suggests that the propensity to spend out of
realized gains is likely to be greater than the propensity to spend out of
unrealized gains.
Although our asset-class analysis of detailed disaggregated data is
still at an early stage, preliminary examination finds that the data are
consistent with the hypothesis of differential spending propensities by
asset type and by whether or not capital gains have been realized. For
example, purchasers of existing homes, on average, appear to take out
mortgages about twice the size of the unamortized mortgage that the
typical seller cancels on sale. After accounting for closing expenses, the
remaining unencumbered cash is available for debt repayment, acquisition
of financial and nonfinancial assets, and spending.
We have no direct evidence, of which I am aware, on the way that
such funds are used. However, we can make use of several surveys that have
explored how cash-outs associated with mortgage refinancing and home
equity loans are expended. Typically, these surveys indicate that
households allocate so-called cash-outs--that is, the amount by which a
refinanced mortgage exceeds the pre-refinanced outstanding debt--to
repayment of nonmortgage debt, acquisition of financial assets, outlays
for home improvement, and personal consumption expenditures in roughly
equal proportions.
Our interest, of course, is primarily on spending; extracting home
equity to repay debt or to purchase financial assets merely reshuffles
balance sheets and, at least immediately, does little to affect economic
activity. If these survey results are taken at face value and are applied
to the case in which the home changes hands--as distinct from, say, a
refinancing-- the amount of personal consumption expenditures generated
from realized capital gains on the sale of homes, financed through the
mortgage market, represents approximately 10 to 15 cents on the dollar. 1
Of course, in addition to realized capital gains from the turnover
of existing homes, there is a considerable amount of cash that is
extracted from home equity without a home sale, principally from
refinancing cash-outs and from home equity loans. Both types of equity
extraction have risen considerably in recent years, in line with the
marked rise in unrealized capital gains on homes. Some preliminary
calculations suggest that the total of equity extractions from unrealized
capital gains on homes that is spent on consumer goods and services per
dollar of capital gains is a fraction of the spending engendered by the
gains realized through the sale of a home. 2 3 This difference occurs, to a large extent, because the net
extraction of equity is much higher among homes that have turned over than
among those that have not.
While data on home mortgage debt and house turnover can be used to
analyze the particular channels through which capital gains on homes spur
consumer outlays, the financing linkages between stock market capital
gains and consumer spending are less clear. Homeowners typically own one
home, which they hold, on average, for nearly a decade. Financing is
almost exclusively through the mortgage market, and equity extractions for
spending, accordingly, are readily identified. Stocks, in contrast, tend
to be held in portfolios that have far greater rates of turnover than
homes, and financing sources are much more diverse and changeable.
Moreover, although gains in defined contribution plans, IRAs, and other
tax-deferred accounts almost surely affect consumer spending, the
complicated tax treatment and restrictions on the use of those funds make
the connections between capital gains in these accounts and spending quite
indirect.
Nonetheless, even setting aside all pension-type assets, household
capital gains on directly held equities and mutual funds in recent years
have been two to four times the size of overall gains on homes. The sheer
size of such gains suggests that capital gains on equities have been a
more potent factor in determining spending than gains on homes. In fact,
if we accept a total net wealth effect on consumption of 3 to 5 cents on
the dollar, and if further analysis supports the larger net spending
propensities from capital gains on homes suggested by mortgage and survey
data, then the propensity to spend out of each dollar of stock market
gains would be less than the propensity to spend out of a dollar from
gains on homes, but still larger in overall dollar magnitude.
Of course, these quantitative magnitudes are tentative, and a great
deal of additional work will be necessary to better understand and to
confirm the nature and magnitudes of the relationships between capital
gains on houses and stocks--realized and unrealized--and consumer
spending.
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