November 12, 2011 · 0 Comments
By Dean Baker:
An NYT article discussing the impact of the European sovereign debt crisis on the U.S. economy raised the possibility that it could lead to a fall in the stock market, which would then slow consumption. It is worth noting that consumption tends to respond with a lag to changes in the stock values, and even then the impact is relatively limited.
For example, the tech crash began in March of 2000, however consumption rose by 3.8 percent, 4.0 percent, and 3.6 percent in the following three quarters. If a euro meltdown were to take a big toll on the U.S. stock market before the end of the year (more than it already has), then its impact through this channel would not be felt much before the end of 2012.
It is also worth noting that the impact over lower stock prices on consumption is not likely to be very large in any case. The stock wealth effect on annual consumption is usually estimated at between 3-4 percent. If stock prices fell by 25 percent because of a meltdown in the euro zone, this would reduce stock wealth by around $4.5 trillion. Using the higher end 4 percent estimate, this would imply a reduction in annual consumption of $180 billion or 1.2 percentage points of GDP. This is hardly trivial, but given that the actual effects are likely to be less than this, the effect of a euro meltdown on stock prices is probably not going to be the biggest cause for concern from the standpoint of economic growth.