Net Worth is Down and that May Explain Why Stimulus Wasn’t Particularly Effective

This week saw the release of the Federal Reserve’s Survey of Consumer Finances. The news isn’t good. Median net worth fell 38.8 percent from 2007 to 2010. Predictably, the unhealthy diagnosis has occasioned a healthy dose of political posturing. For its part, the White House was quick to note that “the entire decline in household wealth took place before President Obama came into office” and that total wealth “has risen every year since he came into office.”

E21, in turn, pointed out that it was a little odd for the White House to emphasize the aggregate numbers rather than the median:

The claims made by the White House are disingenuous (at best) because they ignore the median U.S. household and focus instead on the increase in overall wealth, which has largely come from gains in the stock market. The White House is essentially saying that we shouldn’t worry about the plight of the typical family because Warren Buffett’s stock holdings have gone up in value by tens of billions of dollars since March 2009. The focus on aggregate household net worth is extremely comical when compared to previous statements made by the President and others in his Administration about the country’s lamentable concentration of wealth and income in the hands of a “fortunate few.” Someone should ask President Obama if this means we needn’t worry about income disparities anymore because total household income is up nearly 20% on an inflation-adjusted basis over the past 10 years?

Framing aside, there is an important policy implication of such a large fall in net worth. Richard Clarida of Columbia University explained this point way back in March of 2009:

There is a second reason while the bang of the fiscal package will likely lag behind the bucks. Even if the global financial system soon restores some semblance of order and function, the collapse in global equity and housing market values has so impaired household wealth that private consumption (which represents 60% to 70% of GDP in G7 countries) is likely to lag – not lead – economic growth for some time, as households rebuild their balance sheets the old-fashioned way – by boosting their saving rates.

In our working paper last fall, Veronique and I explained this point further:

The current recession has resulted in an unprecedented collapse in net wealth. In other words, it is a deep “balance sheet”‖recession. But with personal wealth diminished and private credit impaired, some economists believe that stimulus is likely to be less effective than it would be in a different type of recession. This is because consumers are likely to use their stimulus money to rebuild their nest eggs, i.e., to pay off debts and save, not to buy new products as Keynesian theoreticians want them to.

The White House is interested in escaping blame for the collapse in median net wealth. That’s understandable; that’s what White Houses do. It is harder to escape from the policy implications of a balance sheet recession.