Paying off mortgages would also have provided $700 bil. stimulus via wealth effect

Half-jokingly, I yesterday noted that For $3 trillion less than bailout, we could have paid off every U.S. mortgage!.

I should have mentioned an additional attraction of bailing out bad mortgages rather than bad banks: Paying off mortgages would have dramatically stimulated the economy and pulled us back closer to potential GDP. How? By boosting demand, thereby increasing the profitability of employing currently underutilized resources, via “the wealth effect”:

A one-dollar increase in housing wealth or stock wealth each lead to a long-run increase in consumer spending of about 5.5 cents.

Eighty percent of the effect of housing wealth on consumer spending — about 4.5 cents — occurs within one year while it takes several years for stocks to have the same effect on consumer spending.

Given that “The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion”, paying mortgages rather than banks would have generated over $700 billion in stimulus.

Posted by James on Friday, April 17, 2009