Feeling poor? A reverse wealth effect could make spending worse for Canadians | Job Binary

If earnings can’t keep up with the 6.8 percent inflation rate, most Canadian wage earners will have to take cuts.

But economists who study financial behavior have found that even those who can keep spending are looking for ways to cut back.

Anyone who got less than a 1.8 percent pay raise this year took a pay cut of more than five percent. “real” or after inflation income. This means that those who don’t save and spend what they earn have no choice but to buy less or go into debt.

And retailers are starting to take notice. Earlier this month, shares of US chains Target and Walmart and Canadian Tire fell sharply as sales fell on the bottom line, leading markets fell.

Call for savings

But there are growing signs that it’s not just people with no savings who are looking for ways to spend less. Research on the so-called “wealth effect” has shown that many Canadians who have invested in real estate, stocks or cryptocurrencies are not immune to their desire to save.

“As wealth increases, we expect consumption to increase, and as wealth decreases, we expect consumption to decrease,” said Mark Kamstra, an economist who studies behavioral finance at York University’s Schulich School of Business in Toronto.

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Although initially based on economic ideas about how people should behave, the wealth effect actually occurs in the real world, multiple studies have found.

While some economists initially argued that this effect only applied to liquid investments, such as stocks or bonds, where the income can be earned and spent, a growing body of research shows that your home’s notional value is worth it—even if you don’t plan to sell it. and extracting value—can change your willingness to spend.

With home prices rising 20% ​​a year, it’s hard not to feel rich even if homeowners aren’t planning to sell. (David Donnelly/CBC)

Those who have studied the wealth effect include Bank of Canada Governor Tiff Macklem in 1994 when he was an ordinary central bank researcher, concluded that the phenomenon is real. However, there is still debate and even conflicting research about how it works. As Kamstra explains, while the theory presents a simple model with a few variables, the real world is inevitably complex and messy.

“There is good reason to fear that steady or falling stock prices could exacerbate the economic slowdown by reducing household consumption spending,” the US National Bureau of Economic Research said in a report.

Rich in the house

The report concludes, however, that “the housing market appears to be more important than the stock market in influencing consumption in developed countries.”

Macklem, who studied national wealth as a whole rather than looking at individuals, hypothesized that the reason things like stocks and bonds have less impact is because fewer people own them. Compared to owning a home in Canada is about 70 percent.

Of course, the classic anecdotal example of the wealth effect is housing and car sales, where as the prices of relatively modest homes in the neighborhood begin to rise, new and sometimes expensive cars begin to appear in driveways.

SEE | Home sales are slowing, as are prices:

Canada’s housing market is showing signs of cooling as interest rates rise

Analysts say higher interest rates are causing a slowdown in Canada’s hot housing market, leading to fewer sales and a slight drop in average sales prices in March.

Anecdotally, there are studies of support from the Reserve Bank of Australia (RBA), the equivalent of the Bank of Canada Down Under.

While Australian house prices rose by around 10 per cent a year in 2015, RBA research found there was “a robust horizontal relationship between changes in housing wealth and new vehicle registrations”.

Not only that, but the authors put a number on it that shows each percent jump in housing wealth. led to a half percent increase in the purchase of new cars.

The psychology of wealth

The reason the housing example is particularly interesting is that most homeowners who bought cars did not plan to sell their homes to realize the increase in value. This shows a psychological effect.

“I mean, if you’re 50 years old and your house doubles in value, are you rich?” Kamstra asked rhetorically. “What are you going to do? You still have kids in high school. You’re not going to move out next door. You’re not going to downsize. What’s the point of this wealth?”

He points to another UK study that shows the strength of the wealth effect depending on individual circumstances. For example, older homeowners considering downsizing are more responsive to their home’s notional value when making spending choices.

Do you feel rich enough to buy a Lamborghini? It’s not a myth, a study by the Central Bank of Australia found that people with rising house prices bought more new cars. (CBC)

Likewise, those who own securities such as stocks or hold a stake in cryptocurrencies are the ones who feel the effects of the ups and downs of these investments the most. A 2018 University of Ottawa study showed that “financial and housing wealth have a significant impact on Canadian consumption” and that homeowners tend to use their homes exclusively as homes. proverbial bank when house prices are rising and interest rates are low.

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As many commentators have observed on home equity lines of credit, or HELOCS, Canadians may have gone too far borrowing up to 65 percent of the value of their houses to spend on repairs. As interest rates rise and home prices fall, such borrowing and spending may decrease.

A shopping spree

While those with blue-chip portfolios are poised to weather the market’s decline, the Mutual Fund Institute of Canada reports that mutual fund holders sold billions of dollars of their investments in March, a trend that could widen if stocks fall further. lock in decline. At one time, the merchants were new to the market Stop opening the game and cryptocurrency boom He may have felt rich when prices went up, but he may feel poor now, Kamstra said.

Conflicting studies show that even with access to historical data, it is not easy to detect the impact of the reverse wealth effect. It’s even harder to measure in real time, but pollster Nick Nanos says there are signs we may already be seeing its effects.

“Canadian consumer confidence continues to decline with negative pressure across all measures monitored, including job security, property values, personal finances and the outlook for the economy,” Nanos said in a confidence data release this week.

Whether you spend less because you’re really poor or just feel like it, pinching pennies can be a natural impulse that’s hard to resist when your future wealth seems uncertain.

Follow Don on Twitter @don_pittis

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