What’s Been Weighing on Consumption? An Overview of the Recent Experiences of Different Types of Households
When most economists think about consumer spending, they start by thinking about an individual household. A household’s spending patterns depend on its economic environment. That environment includes the household’s income, its wealth, and the return to saving it faces. It also includes the household’s ability to borrow and the uncertainty about its future income and spending needs. In addition, the household’s spending depends on its preferences—such as its patience and aversion to risk—and any behavioral limitations for the household—such as an inability to plan effectively.
The intuitive appeal of this framework makes it a natural starting point for analyzing aggregate consumer spending. Empirical models of consumption commonly start from an implicit assumption that a single representative household accounts for all spending, so that aggregate consumption depends on aggregate income, aggregate wealth, the average interest rate for the economy as a whole, and so on. Such models are not only straightforward to specify but also convenient from a practical point of view because U.S. statistical agencies publish timely estimates of those data at a quarterly frequency.
Of course, it is widely understood that the results from such models only approximately describe the actual dynamics of aggregate consumption. The actual dynamics reflect the choices of millions of heterogeneous households—households that face very different economic circumstances and have different preferences. Therefore, a key question for analysts and policymakers is whether empirical models of aggregate consumption based on the representative household framework produce only small errors or could be astray in more significant ways.
Indeed, the dramatic developments in the U.S. economy and financial system in recent years may have diminished the usefulness of that traditional approach to modeling aggregate consumer spending. Different types of households had vastly different experiences before, during, and after the recent financial crisis. Further, aggregate consumption has failed to see the robust growth in this economic recovery that it has typically experienced in past recoveries—as can be seen in Figure 1 (available in the PDF), which plots the path of real personal consumption expenditures following the most recent business cycle trough (the thin red line) as well as the average path of this series following the cyclical troughs in 1970, 1975, 1982, 1991, and 2001 (the thick black line). Some analysts have argued that the behavior of certain subgroups of the population—such as those with very large amounts of debt—is contributing importantly to the weakness in aggregate consumer spending. If they are correct, then the usefulness of the traditional approach to modeling aggregate consumption depends on the degree to which the historical relationships between the aggregate explanatory variables capture such behavior.
As yet, there is no consensus about how best to capture heterogeneity in empirical models of aggregate consumer spending. Further, lags and gaps in data about individual households have made it difficult to even gauge the importance of doing so. Potentially, though, achieving a better understanding of the ways in which heterogeneity across households affects aggregate consumer spending could make an important difference in forecasting economic outcomes and thereby an important difference in the conduct of monetary policy. The goal of this meeting at the Federal Reserve is to fill some of the holes in our understanding. This paper presents an overview of the issues to lay some groundwork for the more detailed discussions of specific aspects of heterogeneity in the other papers.