| Description |
The objective of this dissertation is to make a contribution to our understanding of the influence of asset prices and their fluctuation on U.S. macroeconomic conditions. It will be argued that asset prices, by their very nature forward-looking economic variables, both influence and are influenced by the real sector. The view put forth here is in contrast to the standard narratives of rational agent behavior and efficient pricing of financial assets. Under the assumptions of both theoretic paradigms, asset prices respond passively to the issuing firm's fundamentals and expected future profits. Asset mispricing, i.e., price divergent from fundamentals, was thought to be insignificant, as it was widely believed that destabilizing speculation would be unprofitable. If price change were acknowledged, the connection between the two was thought to be through "wealth effects" caused by asset price gains, 'exogenous shocks,' or the 'financial accelerator.' This dissertation highlights three gaps created from standard or predominant views where asset price inflation and financial sentiment have a merely moderate influence. Chapter 2 seeks to address the question of how consumption could remain robust in the face of stagnant wages, and discusses the possible explanatory power of the wealth effect and the rise in private credit in providing an answer. In addition, the chapter shows that the link between consumer spending and asset prices is more closely aligned than that of net worth and spending following 1996. Chapter 3 addresses the question of how U.S. households' access to credit could increase at a time of falling savings. It looks at the components of net worth and net flows of saving and asset revaluation as well as their effect on the supply of domestic credit. It finds a multidirectional link between credit and asset price growth based upon the following: (a) asset price growth has been the primary factor of household net worth, (b) credit growth has been a key determinant of asset price change, and (c) the expansion of credit has Granger-caused capital gains after the mid-1990s. Chapter 4 provides an alternative explanation of how asset prices influence the real economy. The explanation clarifies the trends and questions highlighted in Chapters 2 and 3. In addition to showing three direct channels of effect and empirical findings, the chapter highlights the influence of financial sentiment on asset values. The change in market sentiment causes disparate effects on the assets and liabilities of a firm's balance sheet. I show that a potential discrepancy arises on the asset side when the expected profitability of the borrowing firm changes at a rate greater (or less) than the initial value of the issued security, which acts as a liability for the firm. |
