Economic Report President

With respect to leverage, the degree of LTCM’s leverage caused therisks in its portfolio to be transmitted more rapidly to other marketparticipants. Creditors to hedge funds now appear to be reducing theamount of leverage they are willing to provide, which is another positivedevelopment. In addition, bank regulators can employ their existingregulatory tools to induce banks to make more prudent decisions.The working group is evaluating whether the government should domore to discourage excessive leverage, and if so, what specific stepsmight be appropriate.FINANCIAL MARKET INFLUENCES ON SPENDINGThe financial market developments described in this section havehad a significant impact on household and business spending. Thisimpact has been felt through several channels, including wealtheffects, effects on interest rates, and effects on the availability ofcredit to businesses.Wealth and ConsumptionAn increase in a person’s net worth raises the amount that he or shecan consume, either today or in the future. Statistical evidence suggeststhat consumer spending has tended to rise or fall by roughly 2 to4 cents per year for every dollar that stock market wealth rises or falls.This wealth effect usually occurs over several years, but much of theadjustment is seen within 1 year. The effect might be larger today thanin the past because more Americans own stocks: the Survey ofConsumer Finances shows that 41 percent of U.S. families ownedstocks directly or indirectly in 1995, compared with 32 percent in 1989.However, there is little direct evidence on this point.The dramatic increase in stock prices over the past few years hasprovided a significant impetus to consumer spending. Applying thehistorical relationship cited above to the change in total householdwealth (which includes other assets and liabilities as well as stocks),one could conclude that rising wealth boosted consumption growth bynearly a percentage point during 1998, after a similar increase during1997. Robust spending has, in turn, led to a dramatic decline inhouseholds’ saving out of income from current production, with thepersonal saving rate falling to a historical low of 0.2 percent in thethird quarter of last year. (Net private saving, which combines personalsaving and undistributed corporate profits, has also declined asa share of national income during the past few years, but less sharplythan has personal saving.)The sharp decline in household saving in recent years became moreapparent after the annual revision of the national income and productaccounts in July 1998. Prior to the revision, capital gains distributionsby mutual funds had been included in personal income (just as interestpayments are), which bolstered measured personal saving. But67