The Wealth Effect
The doctrine of the “Wealth Effect” has long formed the official foundation for the monetary policy of the Federal Reserve. The Wealth Effect has been described in numerous Fed papers, including by San Francisco Fed president Janet Yellen in 2005. She wrote, “As part of its analysis of demand in the economy, central bank models have long incorporated the wealth effect of house prices and other assets on spending.”
In November 2010, after inflating asset prices for two years through zero-percent interest rates and QE, Fed Chair Ben Bernanke explained the concept of the Wealth Effect to the American people via a Washington Post editorial.
The Fed’s “strong and creative measures” would inflate stock prices, which would lead those holding stocks to feel wealthier and more confident, and then they’d spend a little more, and some droplets of this might trickle down to the people that are working in the real economy.
The National Bureau of Economic Research (NBER) did a study on the Wealth Effect, trying to quantify it, to determine how much richer the rich have to become to have x% impact on the overall economy, and how long this boost lasts before it fades.
