Consumption Spending (Macroeconomics)

Saving grace
May 3rd 2007
The Economist
[It sounds weird, but could higher interest rates boost consumer spending? In theory, yes. It is intuitive to think that when interest rates rise, people would save more and, therefore, consume less--this is called the substitution effect. But interest rates affect consumer spending in another way--the income effect. When interest rates rise, people earn more interest income from their savings and, consequently, they consume more. When the income effect is stronger than the substitution effect, higher interest rates can boost consumer spending. Usually, the two effects tend to cancel each other out. So, it is not a hanging offence if one simply assumes that interest rates do not affect consumer spending one way or the other.]

November 7, 2002
As the Rich Get Richer, Are They Buying More?
The New York Times
[This article emphasizes the idea that consumers react to changes in their lifetime (or, permanent) incomes and tend to ignore income changes that they think are temporary. What's the evidence for this? Income inequality has been rising sharply in the US since the 1970s, but consumption inequality has not increased very much at all. This could be because those who have become poorer (richer) think that although things look bad (good) at the moment, the future will be great (awful) and so there is no need to cut back (boost) their consumption spending.]

October 30, 2002
Consumer Confidence at 9-Year Low, a Warning on Economy
The New York Times
[Note that (a) consumer confidence is periodically measured by the Conference Board, a private company; (b) consumer confidence is directly related to how much we plan to spend; (c) decreases in consumer confidence raise fears that the economy is heading for a recession.]

June 8, 2002
Doubts on Economic Index Create Doubts on Recovery
The New York Times
[This article has a good review of the history of the measurement of consumer confidence in the United States. It also critically examines the usefulness of consumer confidence data. The University of Michigan's Survey of Consumer Sentiment is--along with the Conference Board's consumer confidence index--one of two popular measures of consumer confidence. But, honestly, are they good predictors of future levels of consumer spending? One study "found that low-income households constantly and optimistically overestimated their future incomes". Besides, the overall index aggregates the survey answers of too many different groups of people; examining the raw data for various groups may be more useful than looking at the overall number. Also, it is not clear whether high consumer confidence leads to economic growth or whether economic growth leads to high consumer confidence. Nevertheless, "Forecasters have used past consumption, past income, past changes in interest rates and past returns to the stock market (to forecast future consumer spending). If you use both confidence indexes, then you can improve your forecast by about 13 percent." Which is not bad at all.]

April 8, 2002
THE OUTLOOK: Consumer Spending: A Sentimental Journey?
By Steve Liesman
The Wall Street Journal
[This is another article that has a good review of the history of the measurement of consumer confidence in the United States and critically examines the usefulness of consumer confidence data. One economist quoted in the article believes that consumer confidence as revealed by people to poll-takers is heavily influenced by world events--such as the terrorist attacks on September 11, 2001--while actual consumer spending is influenced by interest rates, taxes, etc. Also, it is not clear whether high consumer confidence makes the economy strong or whether a strong economy leads to high consumer confidence.]

July 8, 1996
Analysis: Consumers Are Driving the Expansion
The New York Times
[This article makes the point that consumers buy such a large part of the goods and services produced in the United States that the ups and downs in gross domestic production often reflect the ups and downs in consumption spending. (The other big buyers of "Made in USA" goods are businesses, the government, and foreigners.) This article also points out that consumption spending increases when (a) interest rates are falling (especially for credit card loans loans), (b) taxes are falling, (c) prices are falling (especially for big-ticket items such as cars), and (d) people feel wealthier (as when stock prices or home prices are on the rise).]


Last updated: June 15, 2008. This page is maintained by Udayan Roy to provide supplementary reading for his students.