Here's today's economic question: If you make a $1,000 profit in real estate will it impact the economy differently than $1,000 in profits from the sale of stock?

You want to know the answer to this question because it may explain how plunging stock prices are impacting the economy -- and whether you will have a job next week or be able to sell your home.

Speaking at a symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming last Friday, Federal Reserve Board Chairman Alan Greenspan said that while much attention has been paid to rising -- and falling -- prices on Wall Street, "movements in the prices of some other assets in the economy -- changes in house prices, for example -- have been steadier, less dramatic, but perhaps no less significant."

"Over the past year and a half," Greenspan points out, "home values have appreciated, whereas equity values have contracted significantly."

Generally, says the Fed Chairman, we spend about 90 percent of our income for consumer goods. So as incomes rise one can reasonably expect an increase in consumer spending. This is important because personal consumption represents almost 69 percent of our gross domestic product.

One catch is that wages and such do not account for all personal spending. About 20 percent of what we spend comes from wealth -- increases in value over time.

A second catch is that we do not spend all wealth in the same way. Generally, says Greenspan, we likely spend 3 percent of stock gains on consumer spending whereas "the amount of personal consumption expenditures generated from realized capital gains on the sale of homes, financed through the mortgage market, represents approximately 10 to 15 cents on the dollar."

This is all very nice but what does it mean in real life?

Until March, 2000 there was no doubt rising share values were the nation's most visible source of new wealth. Huge profits were made from IPOs, employee stock options, and rising share values. But such appreciation was converted into spending at relatively low levels.

Meanwhile, home values have continued to rise over time and at a pace which has generally been greater than the rate of inflation -- meaning that additional spending power, real wealth, has been created. And real estate wealth, says Greenspan, is several times more likely to be spent for consumer goods than profits from stock sales.

In an expanding economy it's nice to have the additional consumption which new wealth on Wall Street represents. It means additional jobs and growth throughout the county.

But what happens if stock prices fall? What's the impact?

Greenspan's statement implies that declines on Wall Street, while not good, have less impact on the national economy than housing declines of equal magnitude.

Greenspan seems to be making these points:

• Consumer spending is the bedrock of our economy. This explains why the business sector can contract and yet the economy does not go into an automatic recession -- or worse.

• Profits from real estate and securities are treated differently by consumers. Real estate profits tend to result in more consumer spending.

• Reduced profits from stock will have less impact on the economy than declining home prices.

• Falling home prices are a precursor to tough economic times. Declines on Wall Street may be tolerable, but a widespread fall in housing prices would reflect substantial economic problems.

• Politicians now in office are unlikely to do well in a contracting economy.

It never happens that the head of the Federal Reserve offers policy suggestions to the President and Congress in plain language. Instead there is a need to parse sentences and divine meanings, but in this case the message is clear: If we are to have an economy which does not needlessly plop into a recession it would be wise to support the housing sector. In practical terms, that means don't fiddle with mortgage interest deductions and adopt policies which encourage construction and ownership.

For more articles by Peter G. Miller, please press here.

Published: September 4, 2001

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