Martin Feldstein, then and now

The rise in consumer spending was not, however, due to higher employment or faster income growth. Instead, it reflected a fall in the personal saving rate. Household saving had risen from less than 2% of after-tax incomes in 2007 to 6.3% in the spring of 2010. But then the saving rate fell by a full percentage point, reaching 5.3% in December 2010.

A likely reason for the fall in the saving rate and resulting rise in consumer spending was the sharp increase in the stock market, which rose by 15% between August and the end of the year. That, of course, is what the Fed had been hoping for.

At the annual Fed conference at Jackson Hole, Wyoming in August, Fed Chairman Ben Bernanke explained that he was considering a new round of quantitative easing (dubbed QE2), in which the Fed would buy a substantial volume of long-term Treasury bonds, thereby inducing bondholders to shift their wealth into equities. The resulting rise in equity prices would increase household wealth, providing a boost to consumer spending.

To be sure, there is no proof that QE2 led to the stock-market rise, or that the stock-market rise caused the increase in consumer spending. But the timing of the stock-market rise, and the lack of any other reason for a sharp rise in consumer spending, makes that chain of events look very plausible.

The magnitude of the relationship between the stock-market rise and the jump in consumer spending also fits the data. Since share ownership (including mutual funds) of American households totals approximately $17 trillion, a 15% rise in share prices increased household wealth by about $2.5 trillion. The past relationship between wealth and consumer spending implies that each $100 of additional wealth raises consumer spending by about four dollars, so $2.5 trillion of additional wealth would raise consumer spending by roughly $100 billion.

That figure matches closely the fall in household saving and the resulting increase in consumer spending. Since US households’ after-tax income totals $11.4 trillion, a one-percentage-point fall in the saving rate means a decline of saving and a corresponding rise in consumer spending of $114 billion – very close to the rise in consumer spending implied by the increased wealth that resulted from the gain in share prices.

And here’s Martin Feldstein in 2013:

The Federal Reserve recently announced that it will increase or decrease the size of its monthly bond-buying program in response to changing economic conditions. This amounts to a policy of fine-tuning its quantitative-easing program, a puzzling strategy since the evidence suggests that the program has done little to raise economic growth while saddling the Fed with an enormous balance sheet.

. . .

Here’s how it is supposed to work. When the Fed buys long-term government bonds and mortgage-backed securities, private investors are no longer able to buy those long-term assets. Investors who want long-term securities therefore have to buy equities. That drives up the price of equities, leading to more consumer spending.

But despite the Fed’s current purchases of $85 billion a month and an accumulation of more than $2 trillion of long-term assets, the economy is limping along with per capita gross domestic product rising at less than 1% a year. Although it is impossible to know what would happen without the central bank’s asset purchases, the data imply that very little increase in GDP can be attributed to the so-called portfolio-balance effect of the Fed’s actions.

Even if all of the rise in the value of household equities since quantitative easing began could be attributed to the Fed policy, the implied increase in consumer spending would be quite small. According to the Federal Reserve’s Flow of Funds data, the total value of household stocks and mutual funds rose by $3.6 trillion between the end of 2009 and the end of 2012. Since past experience implies that each dollar of increased wealth raises consumer spending by about four cents, the $3.6 trillion rise in the value of equities would raise the level of consumer spending by about $144 billion over three years, equivalent to an annual increase of $48 billion or 0.3% of nominal GDP.

This 0.3% overstates the potential contribution of quantitative easing to the annual growth of GDP, since some of the increase in the value of household equities resulted from new saving and the resulting portfolio investment rather than from the rise in share prices. More important, the rise in equity prices also reflected a general increase in earnings per share and an increase in investor confidence after 2009 that the economy would not slide back into recession.

.  .  .

In short, it isn’t at all clear that the Fed’s long-term asset purchases have raised equity values as the portfolio balance theory predicted. Even if it did account for the entire rise in equity values, the increase in household equity wealth would have only a relatively small effect on consumer spending and GDP growth.

There’s no direct contradiction, but the tone sure has changed.

BTW, QE works through the expected hot potato effect boosting NGDP, plus sticky wages, not via reduced consumer saving.

Update:  That was poorly worded.  I meant “in the presence of sticky wages.”  I did not mean to imply QE boosts wages in the short run.

PS.  NGDP bleg:  I saw that eurozone RGDP fell 0.2% in Q1, but can’t find NGDP data.  I hope they don’t report NGDP with a lag like the British do, it’s impossible to calculate RGDP w/o knowing NGDP

HT:  Vivian Darkbloom