January 27, 2010
G-7 Consumption Behavior and Global Rebalancing
Or, the end of the consumption follows a random walk view.
Following up this post last week on Lee et al., here is another analysis of consumption behavior, but this one is cross-country. From the abstract to "After the Crisis: Lower Consumption Growth but Narrower Global Imbalances?" by Ashoka Mody and Franziska Ohnsorge:
We estimate consumption dynamics in the G-7 economies, paying particular attention to the possibility of precautionary behavior in the face of uncertainty. We find that in the short run, continued income uncertainty will significantly dampen consumption growth. As such, consumption in the G-7 economies is unlikely to be the engine that revives global growth. Differences in the pace and timing of consumption moderation have implications for the evolution of global imbalances. With the U.S. experiencing a sharper rise in unemployment and, perhaps, more widespread loss of financial wealth than elsewhere in the G-7, the relative rise of the U.S. savings rate is helping narrow global imbalances. But with a likely earlier recovery in the U.S., this narrowing could be short-lived. Moreover, long-term differences -- in economic and financial volatility and in demographic structures --have been an important source of the imbalances and could soon reassert their prominence.
I had pretty much established in my own mind that the Hall finding that consumption follows a random walk didn't apply to the United States  , but I thought this paper was really interesting because it extended the finding to a broader set of countries.
The authors estimate over the 1984-2007 period:
Δ ln c i,t = α 0 + α 1 c i,t-1 + α 2 Δ ln y i,t + α 3 Δ UER i,t + α 4 V i,t + ε i,t
where the dependent variable is the growth rate of real consumption, c is the consumption share of disposable income, Δ ln y is the growth rate of real disposable income, Δ UER is the change in the unemployment rate, and V is a proxy measure for volatility in the macro outlook (based on Carare and Mody's methodology, using the standard deviation of forecast errors form a FSVAR approach to generating expected detrended output).
The authors estimate several variants; in one set of results, these basic variables are augmented with demographic variables.
Table 5 from Mody and Ohnsorge (2009).
What are the implications for consumption and imbalances?
...U.S. consumption growth, which as noted has been in the 2-1/2 to 4 percent range for almost two decades, will remain weak. After a shrinking of consumption in 2009, consumption growth is projected at 1-3/4 percent in 2010. Elsewhere also, consumption growth will remain below precrisis levels through 2010. In terms of our model, this immediate weakness is being generated by the rise in unemployment, our assessment that GDP volatility (though reduced from its 2009 levels) will remain high in 2010, and by the destruction of financial wealth.
Writing in the context of the Great Depression, Keynes (1937) was quite clear that consumption was unlikely to lead a recovery. As long as, he argued, consumption bears some relatively stable relationship to income -- and particularly if the share of consumption is falling -- production for consumption that is not accompanied by investment will result in aggregate incomes that produce insufficient effective demand for consumption goods. But investment, he went on to note, was highly sensitive to a deep form of uncertainty. The factors that influence the rate of investment, he concluded, were "most unreliable" since they were "influenced by our views of the future about which we know so little" (p. 221). Thus, at a time when consumers are restrained by the uncertainties and fears that we have discussed in this paper, investors are likely to be all the more reluctant to step forward. Our claim that these processes may be working at the same time in all G-7 countries, though to varying degrees, implies that the synchronization puts a further dampener on the strength of the recovery.
Finally, global imbalances are narrower in 2009 because the U.S. has taken an earlier big hit on unemployment and possibly because more U.S. households held risky financial assets that have caused a more widely spread loss of financial wealth. In the countries on the other side of the global imbalances, the rise in unemployment has been slower due to the domestic structure of employer-employee relationships and public support to maintain employment. While U.S. unemployment is projected to rise further, that rise is expected to be relatively modest compared with the projected unemployment increase, especially in Germany. The German forecasts for consumption growth reflect that anticipated increase in unemployment. As such, if events were to develop in line with the projections, the implication is that the unwinding of the global imbalances could reverse quite quickly in 2010.
This is a careful analysis, so it bears close study. I have a slightly different perspective driven by my focus on the ongoing process of deleveraging going. Deleveraging is occuring in the household sector, but that is in part driven by the forces outlined in the Mody-Ohnsorge paper. But what is not directly included is the tightening up of lending standards, and increases in capital requirements. To the extent that the Mody-Ohnsorge models fit well over the 1984-2007 sample period, perhaps ease of financing is not an important determinant of consumption behavior (or is proxied by financial wealth variables). However, I tend to think otherwise (note -- I don't know how one could incorporate easily this ease-of-financing factor in the regression analysis).
Hence, I think it still possible -- although maybe not probable -- that US consumption growth will remain sufficiently muted to constrain the current account to GDP ratio. (And it's important to realize there is not a one-for-one relationship between consumption and the external balance. )
Posted by Menzie Chinn at January 27, 2010 07:50 PMdigg this | reddit
I think anyone predicting consumption levels and the associated global imbalances has to factor in eventual large tax increases, climate change costs, never ending increases in health care costs, aging demographics and the necessary increase in savings rate, and crappy investment returns along with possible further erosion in net worth from housing and now inflated stock and bond prices correcting, otherwise the picture is rather incomplete. And who knows, we may also may succeed in getting inflation to outpace wage gains! Interest rates could even go up????
But I understand that is hard to all get into an equation.
But maybe rising disposable income will increase consumption, and consumers will direct it towards consumer durables from overseas? May work in some US industries, but with US companies involved trade-ables, and some service sector work, it more appears that the developed world will need to meet the emerging world halfway on income. And if we want everyone in the country to take a haircut, as it were, currency devaluation is the typical prescription. It's just that the dollar is highly resistant to devaluation. Meaning I think it would be 25 cents by now, if it weren't the primary reserve and trade currency. It's primary competitor, the Euro, was created in part so currency would be more difficult to devalue by Euro governments, and force fiscal and trade discipline instead. So it's hard to say when this would ever change. The emerging world would have to change it, but they seem to really like the way things are know, in spite of the complaining we hear from the Chinese.
But even without major devaluation, I think the sea change is for trade imbalances to be much moderated by internal economic factors for a long time.
Posted by: Cedric Regula at January 27, 2010 09:16 PM
But to make a long story short, I don't think we have a random walk. More like when Wile E. Coyote goes off the cliff, runs a little longer, looks down and sees no ground immediately below, plummets, and gets stopped by the first rock jutting from the side of the cliff. But it didn't end there...
Posted by: Cedric Regula at January 27, 2010 09:26 PM
How about the statistical phenomenon the reversion to the mean ? It seems to work even on a long term range for the commodities, but not for:
PCE Personal consumption expenditures
In the old time (1960 1970) the CPI was almost obliging the theory
The Producer Price Index: All Commodities would demonstrate the same
Some correlation to be perfected?
Posted by: ppcm at January 27, 2010 11:24 PM
Fed chairman confirmation day
Posted by: ppcm at January 28, 2010 07:59 AM
To reinforce your allusion, and for all those who haven't had the pleasure of seeing a cartoon of Wiley E. Coyote illustrating our feckless government's management of the economy, I would recommend that they cop a chuckle in
Posted by: MarkS at January 28, 2010 12:35 PM
Real consumption? Is that current consumption, consumer durables or both combined? The cost of borrowing should affect consumer durable spending but apparently that variable was left out.
I read some discussion of investment (private gross fixed capital formation?) yet I see no investment variable. Was it tossed out in the specification search?
Volatility indicator X proportion of population older than 65? OK.....
I see the authors are assuming normal distribution of errors or unexplained shocks. Did they test for normality?
Posted by: GNP at January 28, 2010 01:11 PM
haha. Well, it's official. The Senate rolled humpty dumpty back up the hill, and Benron rules for another 4 years.
Geithner emerged relatively unscathed by Congress yesterday, so it looks like the team is intact.
Posted by: Cedric Regula at January 28, 2010 02:04 PM
Thanks for posting this, and providing your commentary. They seem to have evaluated hypotheses about reasonable causal forces and found interesting results.
Posted by: Mike Laird at January 28, 2010 02:59 PM