Even people who can afford to keep spending are seeking ways to cut back, according to studies of financial behaviour
For people whose wages can’t keep up with record-high inflation, belt-tightening is an inevitable reality. But according to studies of financial behaviour, even those who can afford to keep spending are seeking ways to cut back.
With inflation recently edging up to a high of 6.8%, anyone who received a wage raise of less than 1.8% this year effectively saw their "real" or after-inflation income drop by more than 5%, according to an analysis by CBC News. In other words, those who do not save and choose to spend all of their income have no alternative but to buy less – or fall into debt.
But there’s evidence that individuals without savings aren't the only ones searching for methods to save money. Many Canadians with assets invested in real estate, equities, or cryptocurrency are not immune from the desire to save, according to research on a phenomenon known as "the wealth effect."
"What we expect is that as wealth goes up, consumption would increase and as wealth declines, we would expect a decrease," Mark Kamstra, an economist who studies behavioural finance at York University's Schulich School of Business in Toronto, told CBC News.
The wealth effect, which was originally based on economic beliefs about how people should behave, has been proven in numerous studies.
While some economists initially claimed that the effect only applied to liquid investments such as stocks or bonds, where returns could be extracted and spent, a growing body of research shows that the notional value of people’s homes — even if they have no plans to sell them and extract the value — can affect their willingness to spend.
"There are well-known reasons to fear that constant or declining share prices may exacerbate a slowdown in the economy by depressing the consumption spending of households," said a 2001 report for the U.S. National Bureau of Economic research.
Those who hold securities such as stocks or have taken a cryptocurrency position, on the other hand, are the ones who bear the brunt of the impacts when their investments increase and decrease.
According to a 2018 study from the University of Ottawa, "both financial and housing wealth have major influence on Canadian consumption," and that homeowners only tend to utilize their property as a piggy bank when house prices rise and interest rates are low.
That window could be closing soon. As interest rate hikes start to weigh on the housing market, borrowing and spending through home-equity based debt like HELOCs are likely to decline.
And while people with blue chip portfolios may be willing to sit out a market downturn, the Investment Funds Institute of Canada reports that mutual fund holders sold off billions of dollars’ worth of their investments in March, a trend that may expand if stocks fall further, locking in declines.
"Canadian consumer confidence continues to decline with negative pressure on all dimensions tracked, including job security, real estate values, personal finances and forward-look on the economy," said Nanos in a release of confidence data this week.
