PKT message, "Stock Market and the Real Economy", a reply to Clifford

Dear List and Clifford,

Yes, I agree on the point you raised about my first question, but I think I didn't express myself correctly (sorry I'm French !).

What I wanted to know is whether the stock incredible valuation these days is likely to boost consumption by two means :

- First of all, the "direct relation" of the wealth effect, according to which the reacher you are, the more you spend, ceteris paribus. But I know that the biggest consomption growth comes from the persons with low "marginal propensity to consume" to use Keyne's terms, which leads me to the second point :

- Second, there seems to be a "structural change" nowadays, because as a recent reports states out, more and more people do own shares, and therefore participate to the stock expansion. There's like a vertuous circle : the stock goes up, so people want to own shares, so their price goes up, so the stock goes up, and so the stock market seems more and more attractive to non-holders...etc. Plus the so called "New Economy", that makes the stock easier to understand to people because they know they will make all kind of money of any "dot com" company...

Do you think this structural change is likely to have a big impact on the stock market, and therefore to spread wealth -I mean money- to all the people of the social ladder ? If so, I think the gross marginal propensity to consume is going higher, boosting consumption, and therefore the demand-side and growth ?

Or do you still think the main impact of the recent rise in the Dow is on Investment ?

Now the second point you raised is about the ergidicity hypothesis. You're right, I HAVE to postulate rationality and ergodicity and the fantasmagoric neoclassical stuff if I say that "the stock and labor productivity are positively correlated". I'm forgetting this idea right away.

Your last suggestion seems interesting, but let me check I've clearly understood.You wrote

"Let's say that an increase in labor productivity leads to an increase in corporate profits and hence an increase in investment demand. The increase in spending leads to increasing GDP, and a decrease in unemployment."

I do agree if and only if the gains in production -growth- outpaces the gains you supposed in labor productivity, unless productivity increases destroy jobs, and not create as you mentionned. And as far as I know, increases in corporate profits do not automatically lead to higher investment. According to me and in a basic old-keynesian scheme, there can only be investment if the entrepreneurs anticipate a higher consumption -through a market study for example-. The problem is that, in the US at least, people consume more only if they were given more money, that is wages are increasing. So do you agree with the following assertion :

"Let's say that an increase in labor productivity OVER WAGES leads to an increase in corporate profits and hence an increase in investment demand. The increase in spending leads to increasing GDP, and a decrease in unemployment." ???

I do agree with the rest of your explanation :

"As the expansion heats up, workers demand (or central bankers fear they will demand) increases in wages. At this point, markets respond to the fear of increased inflationary pressures and/or restrictive policies by the Fed. This makes the market extremely volatile at the top. If a recession comes, productivity could still be increasing, but equity prices are likely to fall."
Just to add a comment, I'd like to say that this is what Greenspan and all the neoclassics (sorry to mix those two !) do not seem to have understood : wage increases does not create inflation as far as they're lower than labor productivity gains. In other words, there is no Phillips curve if you do not take account of labor productivity gains. But don't get me wrong, I do not deny the statistical evidence of the Phillips curve. He was right in the fifties, mainly because labor productivity was barely increasing and therefore yes, any wage increase would be seen in a greeater inflation rate.

So to me, inflation comes from a gap between labor productivity and wages. Except of course, when structural changes or supply-side shocks appear.

Olivier Giovannoni