ABSTRACT
In October 1987 the stock market crashed, reducing the value of the public's equity holdings by about a half trillion dollars. This sudden decline reduced the market value of the public's wealth significantly. According to a long literature developing the economics of consumption, such a large decline in wealth could be expected to reduce consumer expenditures. The widely accepted theory of life-cycle consumption posits that consumption depends mainly on expected life-cycle income. Income derives from labor and capital, so that changes in wealth can affect expected life-cycle income. The stock market crash produced adverse expectations about the economy which reinforced a negative wealth effect and did not offset it. The episode strongly suggests that the equations are misleading and that changes in the market value of wealth as measured by household net worth or stock prices, whether unanticipated or not, do not have the alleged effect on consumption.
