Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Tuesday, August 27, 2013

Whither the consumer?

Well, I'm back from my summer hiatus. I know you all missed me.

So, I'm looking at some graphs that my colleague, Fernando Martin, prepared relating to the behavior of the U.S. economy. First, let's take a look at real GDP. Actually, real GDP per capita, with the population defined as those aged 16-64 plus those aged 65+ and counted as part of the labor force (non-retired). The data (1948-2013) is logged and a linear trend is fit through the sub-sample (1955-2007). Here is what you get:

It is rather remarkable how well the linear trend fits the historical data despite the significant demographic changes that have occurred over this sample period. But, there you have it.

Of course, as the great Eugen Slutsky pointed out, the interaction of chance events could generate periodicity where none actually exists, see: The Summation of Random Causes as the Source of Cyclic Processes. In layman's terms: that linear trend you seen drawn through the data above might just be a figment of your imagination. So we should always be careful when interpreting deviations from statistical trend.

Having said that, there is something rather odd about the recent recovery dynamic. In the U.S., the business cycle is mostly about investment spending. Consumer spending (non-durables and services) is relatively stable. And in the typical recovery dynamic, consumption and investment tend to move together (this applies to booms as well).

The following figure plots (detrended) real per capita consumption (non-durables and services) and investment (includes consumer durables). With the onset of the 2008 recession, we see the sharp drop in consumption and the even sharper drop in investment. The decline in both series initially was not unusual--apart from the severity of the shock. What is unusual is the subsequent recovery dynamic: consumption and investment appear to be heading in different directions, relative to their historical trends.

Here's the same data, except with investment decomposed into residential and non-residential investment.

So, residential investment behaves largely like other forms of investment, except that it is considerably more volatile. In particular, the recovery dynamic for residential investment looks like what one might expect, given the large negative shock in that sector. And yet consumer spending continues to fall away from its historical trend, even as residential investment recovers (albeit, slowly).

Can someone point me to a theoretical model that generates this type of consumption-investment dynamic during a recovery?

Household deleveraging surely has to be a big part of the explanation here--see the following diagram (source). [It is curious to  note, however, that consumption seemed below trend even during the mid-2000s boom period--will have to think about that.]

These debt-service ratios are now at or close to their historical lows. Is the consumer now ready for a major comeback?


  1. I'm not seeing much discussion about income here. And as someone who sells stuff and knows demand drives the entire locomotive, I'm pretty sure that if household incomes take a big hit and don't much recover, nothing else recovers either. It's a cap on spending, in effect. This is the dog that wails all the tails. If the 'chance event' is 100% then there's not much doubt in terms of 'chance,' right?

    1. And if there is no income recovery, how come we keep hearing about the current and "economic recovery"?

    2. Anonymous: the GDP is a measure of aggregate income. By income, are you referring just to labor income?

  2. I guess a forever upward sloping real gdp figure means little if the income from it keeps going to a smaller group. To me, deleveraging is just code for buying back equity in your life, and that appears to be the path for all of us for the forseeable future. I assume if one examined the public debt per person in our country, far more people would actually have negative net worth than you realize.

  3. Do you think there could be measurement error with the investment stats ? McGrattan and Presoott talk about the importance of intangible investment.

    1. We should always worry about measurement error. But could you please elaborate?

  4. Replies
    1. Nice flowcharts. What is one supposed to do with them?

  5. The behavior of consumer spending could be a function of the income shift towards lower consumption propensity households. This started around 1980, but the effects were masked by consumption smoothing. Around 2000, the high consumption propensity households realized it was a permanent, not temporary, adjustment to their income trend. As a result they began to delever, and their true income-constrained consumption behavior is now evident.

    I'm sure I've left out some general equilibrium aspect.

  6. "Anonymous: the GDP is a measure of aggregate income. By income, are you referring just to labor income?"

    Can't speak for Anonymous, but that seems a likely rough approximation. GDP can be too reflective of those whose spending will vary relatively little with changes in income. GDP can potentially see a tremendous rise despite the vast majority of incomes stagnating or declining versus inflation. And consumer spending depends heavily on that vast majority of lower incomes.

  7. "Can someone point me to a theoretical model that generates this type of consumption-investment dynamic during a recovery?"

    I can't but show the graph to a mathematician/engineer who is expert on dynamical systems, they might respond with "looks like a classical coupled oscillator" (or similar) and work from there. I did this once with a plot of HFT price data and the explanation of a coupled oscillator was (probably) a good explanation of the mechanism.

  8. I read this elsewhere, but...
    If you look at h-1, h-3, and h-9 sub 2011 Dollars you see income declining in all quintiles from 2006 to 2011. That would account for a drop in consumer spending I recon.

  9. Steve Williamson explains this in his intermediate macro textbook, the chapter on real intertemporal model.
    Which by the way is easily the best intermediate text out there.