Will higher stock prices lead the economy upward? Latest Fed numbers on family net wealth say it could be happening

12/13/2010 10:38 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The Federal Reserve may not be having much luck using its $600 billion quantitative easing program to reduce interest rates in order to stimulate the economy—the yields on 10-year Treasuries are climbing--but it looks like the wealth effect might be ready to ride to the rescue.

Household wealth in the United States rose by $1.2 trillion in the third quarter, the Federal Reserve reported on December 9 thanks to rallying stock prices. Household net worth grew by a 9.1% annual rate in the quarter after dropping at a 9.9% annual rate in the second quarter of 2010. The increase would have been even greater except that home prices continued to fall in the quarter, taking a bite out of family wealth.

The value of family holdings of stock rose by $978 billion in the quarter while the value of real estate holdings fell by $748 billion. That was the biggest drop in the value of household real estate since the first quarter of 2009.

The wealth effect is tough to measure and not all economists agree that family net worth has a significant impact on consumer spending. I think those skeptical arguments are well taken in normal times, especially because stock ownership in the U.S. is concentrated at the upper end of the income scale. Most families, even in the age of IRAs and 401(k)s don’t have much invested in stocks. The family home remains the biggest asset for most U.S. families by far.

But these aren’t normal times.

And I think given the extent of current economic uncertainty the wealth effect is probably more pronounced than it would be if the economy weren’t struggling to rebound from the Great Recession. A rising Dow may not be making the average family wealthier to any significant degree, but seeing that news even out of the corner of the eye is reassuring.

If stocks are going up, the economy can’t be headed to hell in a handbasket right?

Whatever the reason, consumer spending climbed at a 2.8% annual rate in the third quarter, the fastest growth in almost four years. And economists are starting to talk about a 3% growth rate for the quarter that ends with December.

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