Does the Turbulence of the Stock Market Terrify Consumers? Evidence from a Panel of U.S. States Using Pooled Mean Group Estimation

Abstract

This paper elucidates the influence of stock market volatility on U.S. consumption using pooled mean group (PMG) estimation of 46 states over the period from 1998 to 2017. The findings confirm that the PMG estimates of the effect of stock market volatility on consumption are robust to the lag order, lag selection criteria, and outliers compared with the mean group (MG) and the dynamic fixed effect (DFE) methods. I explore that stock market volatility reduces total consumption, nondurables, durables, and services consumption. However, durables consumption responds negatively to stock market volatility more than services and nondurables consumption, respectively, and has a higher speed of adjustment to market disequilibria. Although Romer (1999) uncovered the adverse effect of stock market volatility on durables consumption during the Great Depression, the current investigation reveals that the stability of the stock market plays such a critical role in redressing market disequilibria and influences not only durables consumption but also nondurables and services consumption. In addition, the data provides evidence to reject the null of no cointegration among the models’ variables, which contrasts with the pervasive idea surrounding the consumption function. Since the short-run income elasticities are far less than the long-run ones, I reconfirm that the permanent income hypothesis (PIH) is valid in the United States. As a result, the short-run efficacy of macroeconomic policies in resolving market disequilibria is limited, as it takes time for consumers to build confidence regarding the permanency of their income.