The key chart

Examining wealth effects

Households (HH) in the euro area (EA) have been running persistent financial surpluses of between 2-3% GDP since the GFC. I considered the implications of these trends for the choice of policy mix in previous posts (see “Policy reboot 2020”). In this post, I examine the implications for the resilience of HH consumption in the face of the Covid-19 crisis.

HH net wealth (HNW), the difference between the value of HH assets and liabilities, is an important determinant of private sector consumption. Given that HH consumption accounts for 54 cents in every EURO of GDP, it is also an important determinant of overall GDP growth in the EA.

Changes in wealth affect consumption in the short run as HH feel richer or poorer and become more or less confident. The level of HNW is also an important driver of long term consumption since, along with income from employment, it determines the amount of economic resources available to HHs.

HNW hit a new high in absolute terms (€52trillion) and as a multiple of disposable income (7.2x) at the end of 3Q19. This included non-financial assets (NFAs) of €34trillion, largely in the form of housing, and financial assets (FAs) of €26trillion, netted off against financial liabilities (FLs) of €8trillion.

The growth in HNW reflects not only the build-up of FAs, but also revaluation gains in these and other NFAs. As discussed in “Fuelling the Fire”, Quantitative Easing has stimulated asset prices and led to increased housing and financial wealth (see graphs above and below).

Revaluation gains of NFAs have been particularly important in Portugal, Greece, Spain, Germany and Austria. However, ECB estimates suggest that while residential property prices remain undervalued in Greece, they were overvalued by 12%, 16% and 18% in Portugal, Germany and Austria respectively even before the impact of Covid-19 as felt.

Potential revaluation losses on NFA will have a negative impact on HNW for obvious reasons, but their impact on future consumption (marginal propensity to consume) is more challenging to determine (and varies between micro and macro levels).

To summarise the very extensive economic analysis in this area, the long-term housing effects on consumption are consistently weaker than those of financial wealth. Indeed, in a recent analysis of larger EA economies, the ECB concluded that, “Spain is the only large EA country for which consistently positive housing wealth effects have been estimated.”

Significant heterogeneity exists in terms of the size and structure of HH financial assets. FAs are 2.2x the size of EA GDP on average, but above average in the Netherlands (3.6x), Belgium (3.0x), Italy (2.5x) and France (2.4x). Higher gearing to the value of financial assets in these economies is offset by the “absolute cushion” of higher per capita FA holdings in the Netherlands (€167k), Belgium (€121k) and France (€86k). However, in aggregate, Italian HHs have higher gearing than average but lower than average holdings of FAs per capita (€72k versus the EA average of €75k). Other Southern European economies also have smaller cushions in terms of FAs per capita – Greece (€25k), Portugal (€42k) and Spain (€50k).

FAs consist mainly of liquid assets (currency and deposits) and pension and life insurance-related assets. These assets account for 70% of total HH FAs with the remainder held in higher risk products including equity, debt and shares in investment funds. The share of higher risk assets has fallen from 40% pre-GFC to 30% currently suggesting that the negative impact of recent market falls may be less than after the GFC. In addition, HHs in Greece (59%), Portugal (44%), Austria (40%), Germany (40%) and Spain (39%) hold higher amount of their financial assets is liquid assets. However, on a per capita basis, the largest liquid holdings are in Belgium (€38k), Austria (€33k), Germany (€31k) and Ireland (€31k).

Conclusion

The stock of HH wealth in the EA has risen to new highs in absolute terms and as a multiple of disposable income and represents an important economic resource in the face of the Covid-19 crisis.

Revaluation gains of both NFA and FA assets have been important drivers of recent HNW growth, but both will turn sharply negative in the current environment. At the macro-level, long term housing effects on consumption difficult to measure but are consistently weaker than those of financial wealth (with the exception of Spain).

HHs in the Netherlands, Belgium, Italy and France have relatively high gearing to changes in the value of FAs, although with the exception of Italy this is offset by relatively high per capita holdings on FAs. HHs in Southern European economies typically have lower “cushions” in terms of per capital holdings of financial assets.

Since the GFC, there has been a de-risking of HNW holdings away from debt, equity and shares in investment funds in favour of liquid assets and pension and life insurance related assets. Lower risk assets now account for 70% of HH FAs. In addition, HHs in Greece, Portugal, Austria, Germany and Spain hold relatively high amounts of FAs in liquid assets. This suggests that the MPC from financial effects may be lower than after the GFC.

These conclusions come with the obvious caveat that the impact of changes in wealth on HH consumption differs substantially between countries, between NFAs and FAs and between HHs within the same country.

Please note that the summary comments above are extracts from more detailed analysis that is available separately

chris@cmmacroperspectives.com