South-Western College Publishing - Economics  
Stocks and Growth
Subject Economic Growth
Topic Money and the Financial System
Key Words Consumption, Economic Growth
News Story

According to last quarter's data, the U.S. economy is growing at 6 percent while Asian, Latin American and European economies continue to stagnate and contract. The continued strength of the U.S. economy is propping up the global economy. Apparently, the strength of the U.S. economy depends on consumer spending which, in turn, depends on the strength of the stock market. The implication is that global economic health is dependent on the continued strength of Wall Street.

U.S. consumer spending is driven by wages and household wealth. U.S. labor markets are expanding, wages are growing and consumers are spending this wage income. Household wealth has grown by over $3 trillion in the last two years. The stock market increase had added between $35 and $55 billion a year in consumer spending.

The dependence of the global economy on Wall Street raises the question of what would happen if the stock market were to plunge? The answer to this question may affect monetary policy, because if the Federal Reserve, in an effort to cool the economy, were to raise interest rates, it would risk causing a decline in the stock market.

Fed Chairman Alan Greenspan has argued that consumer spending may not be dramatically curtailed by a decrease in the stock market. He argues that Americans have more wealth in the form of home ownership than in their portfolios, and home ownership equity has risen along with stocks. A decrease in the price of stocks that is unrelated to interest rate changes may not reduce housing prices, and thus cushion against a stock market decline.

(Updated April 1, 1999)

Questions
1. According to your text, what are some of the determinants of consumption?
2. How would an increase in wealth affect the consumption function? Aggregate demand?
3. What is the relationship between and increase in aggregate consumption and an increase in real Gross domestic Product?
4. How would a decrease in U.S. wealth affect the Japanese economy?
Source David Wessel, "The Outlook: Stock Market Expands Role in Global Economy", The Wall Street Journal", March 15, 1999.

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