The Wealth Effect Theory

Author: Lü Lixin
Publisher:
Publish Date: 2005-05-01
Features:
1. General Definition of Wealth
Wealth is primarily a micro-concept. For the private sector, wealth refers to the total amount of assets owned by economic entities at a specific point in time, which can be expressed in monetary units. In the history of monetary financial theory, analyses based on portfolio theory, including the determination of the scale variables of money demand in the Friedman and Keynesian schools, are all object-oriented at the micro level of individual or corporate behavior. Because it involves certain microeconomic entities, this is the micro-definition of wealth. The micro-definition of wealth is essentially the concept of asset stock. The assets mentioned here are assets owned by people, and their stock includes both realized and unrealized market values. The wealth of microeconomic entities is mainly composed of monetary assets and non-monetary assets, and there is a certain ratio between the two. In the history of Western monetary theory, regarding the basic form of the money demand function, portfolio analysis holds that the money demand function is mainly determined by scale variables and opportunity costs. In the definition and selection of opportunity cost variables, the relative return rate of all non-monetary assets in wealth is taken as the opportunity cost of holding money. Therefore, when the return rate of non-monetary assets increases, the substitution effect of wealth adjustment will cause economic entities to reduce their holding of monetary assets, leading to a decrease in the demand for monetary assets. Conversely, when the return rate of non-monetary assets decreases, the substitution effect of wealth adjustment will cause economic entities to increase their holding of monetary assets, leading to an increase in the demand for monetary assets. At this point, the ratio between monetary assets and non-monetary assets will change until a new equilibrium is reached.
Macroeconomic wealth refers to, for the non-bank private sector, the total wealth being the sum of real assets, money, bank time deposits, and government liabilities minus the liabilities to banks and governments. The liabilities of economic entities do not affect the total wealth of the non-bank private sector because the liabilities between economic entities are mutual and internal. A liability of one economic entity is an asset of another, offsetting each other, resulting in a constant algebraic sum. If liabilities are treated as negative assets, then the total wealth, total assets, and net assets of the private sector would all be equal, and the total wealth of the non-bank private sector would be equal to the sum of the net assets of all economic entities in the non-bank sector. At the same time, treating government liabilities as the net assets of the private sector clearly expands the total wealth. Only when the private sector pays taxes on the income generated by government liabilities does it lead to a reduction in its net asset value. If government assets rather than liabilities are added to the total wealth of the private sector, the scope of the macroeconomic definition of wealth could potentially be further expanded.
Why is the banking sector excluded from the macroeconomic definition of wealth? When studying the macroeconomic definition of wealth, the banking sector is excluded from the private sector because the banking sector primarily engages in liability operations. Its main assets are also assets of the private sector. Therefore, in a social community that includes the banking sector, there is no aggregate financial asset net worth. When studying the net worth of financial wealth, it is necessary to study either the suppliers or the demanders of financial assets separately. Only