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

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 find that stock market volatility reduces total consumption, nondurables, services, and durables consumption. However, durables consumption responds to stock market volatility to a greater degree than nondurables and services consumption, and adjusts more quickly to market disequilibria. Although Romer (1999) identified 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 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 view concerning 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 US. As a result, the short-run efficacy of macroeconomic policies in terms of resolving market disequilibria is limited, as it takes time for consumers to build confidence in the permanency of their income.