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To: patron_anejo_por_favor who wrote (104501)	5/24/2001 11:52:25 AM
From: ild	Respond to of 436258

interactive.wsj.com May 24, 2001 Capital The Wealth Effect Goes Into Reverse THE STOCK MARKET of the late 1990s spawned a number of myths, in addition to the whopper that stock prices could go up forever. Among them: Even if the bubble burst, it wouldn't hurt much. One story was that investors didn't believe the numbers on their quarterly brokerage statements. Since stock-market winners didn't act as rich as they were on paper, the logic went, they wouldn't pull back much if stock prices fell. Another version began with the fact that half the stock-market wealth is held by the richest 1%, and argued that the fortunate few couldn't spend as fast as their portfolios grew. As Lawrence Lindsey, then a Federal Reserve governor, put it in a November 1995 Fed meeting: "A lot of that increase in stock-market wealth is -- I'm going to use the word -- 'wasted' on people who are unlikely to spend a large portion of it." If that was so, then consumer spending wouldn't fall much when the stock market did. It sounded comforting. But then the air began seeping out of the stock-market bubble; by early April, stocks were worth 30% less than they were the year before. Dot-com debris is scattered widely. Business-investment spending shows few signs of rebound. And after spurting at a 7.6% annual pace in last year's first quarter, consumer spending grew at only a 3.1% pace in this year's first quarter. The current quarter looks worse. Questions that seemed academic curiosities when everything was going right are now critical as the Fed ponders whether to cut interest rates further to avoid a Japanese-style burst-bubble syndrome. See more information about some of the items mentioned in this column. *** Please send comments to capital@wsj.com. We'll post selected replies at WSJ.com/CapitalExchange on Sunday. Just how much did the bull market drive up consumer spending, and how much will the bear market depress it? Has the economy already absorbed the evaporation of $4 trillion in household wealth, or will consumer spending suffer for a while longer if stock prices stabilize? Deploying the platoons of economists at his command, Fed Chairman Alan Greenspan last year ordered an attack on these questions. The answers he got are now informing monetary policy. The bottom line: The aftereffects of the stock market's slide are likely to depress consumer spending for the rest of this year and into next. That restraint on the economy makes the Fed less worried about the risk of cutting rates too much now and causing inflation later. THE WEALTH EFFECT LIVES, the Fed researchers say. Consumer spending eventually rises, or falls, between three cents and five cents for every $1 change in stock-market wealth. There are lingering differences about how long it takes market moves to hit the economy and whether changes in the economy are pushing the wealth effect toward the top or bottom of that range. Mr. Greenspan's economists now say they have settled one big issue: Ups and downs of the stock market don't foreshadow where the economy is headed; they drive it directly. The very households that benefited the most from rising stock prices, the 20% with incomes above $80,000, were the ones who saved less and spent more during the stock-market boom, new Fed research shows. Households without stock didn't change spending habits. Shareholding households are now paring spending. One sign: Tiffany & Co., the tony retailer, says sales at its flagship New York store dropped 15% in the three months ended in April. FED ECONOMISTS QUIBBLE over timing. A squad of New York Federal Reserve Bank economists conclude that consumers respond quickly to the market. "Changes in wealth in this quarter," they say, "do not portend significant changes in consumption one or more quarters later." By this logic, the Fed shouldn't expect much more drag from the stock market's decline. But Fed economists in Washington, dissecting data under Mr. Greenspan's supervision, are increasingly confident that they understand the way the market drives spending. People hesitate to be sure a market move won't be quickly reversed; when it persists, they adjust spending. In short, the economists say, consumers will be reacting to shrinking stock portfolios for another few quarters, one of the Fed's three big worries right now. (The other two: weak business-investment spending and slow growth abroad.) Mr. Greenspan sides with the Washington economists. And the difference between Mr. Greenspan's opinions and those of all other economists is that his matter. -- David Wessel Write to David Wessel at capital@wsj.com