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BankRI, Lardaro on the Economy Series
December 2003

As we move into the holiday season, the economic news continues to be increasingly cheerful. National statistics are signaling an accelerating pace of economic activity based on strong overall economic growth, a falling unemployment rate, and rising consumer confidence. One of the major concerns going forward is whether consumers will be able to sustain the current pace of spending.

This same worry, albeit compounded, occurred in early 2000. At that time, the NASDAQ average reached a quarterly peak of 4,403. After a stunning stock market rally that lasted several years, things began to come unglued in March of that year. When the NASDAQ began to implode, it was generally presumed that consumer spending would collapse as the result of the “wealth effect,” where capital losses in the stock market would force consumers to buy less because of their reduced wealth. To some extent this did occur, but not by as much as many thought at the time. Why? Because while stock market wealth matters in determining consumer spending, so too does home equity. And, for many consumers, home equity wealth affects their overall wealth far more than do stock market losses. This has been especially true for Rhode Islanders.

Since the 1980s, home prices here have continued to rise. But, they failed to keep up with inflation for a number of years, resulting in continual declines in real (inflation adjusted) home prices (see graph).

Ironically, this situation reversed at just about the same time the NASDAQ began its long decline (see graph below). So, in Rhode Island,

 rising home equity wealth offset some if not a major portion of the stock market losses. The result: Consumer spending here did not falter much, even as the stock market was declining precipitously.

What about now? As we move into this holiday season, not only are real home prices in Rhode Island rising sharply, continuing the trend that began in early 2000, but the stock market is moving upward as well, a combination we haven’t seen since the beginning of 2000. This double-barrel increase in wealth should help Rhode Island offset some of the weakness in income and employment that may occur in the next several months.


by Leonard Lardaro

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