Will Consumption Growth Return to Its Pre-Recession Level?
This graph compares the movements in aggregate real consumption during and after the onset of the current and three most recent recessions. The graphs show the first month of a recession as defined by the NBER -- normalized to 1.0 to facilitate cross-recession comparisons -- and the subsequent 22 months after the recession begins (for a total of 23 months, the length of time since the current recession began).
[click to enlarge]
There are several differences between the pattern of real consumption in the current recession as compared to the three other recent recessions shown in the diagram.
First, in every other recession consumption returned to close to its pre-recession value no longer than 9 months after the recession started, and the time period was usually shorter than that (it was 9 months in the 90-91 recession, consumption was hardly affected in the 81-82 recession, and in 2001 consumption was almost back to its pre-recession value after 6 months, and above it after 8 months). In the present recession, consumption stayed relatively flat for 7 months, fell consistently for the next 6 months, stayed flat for a few months after that, and then began a slow increase in month 17. This increase has continued, more or less, through the end of the available date (October of this year). However, even though nearly two years has passed since the present recession began, consumption has not yet returned to its pre-recession level.
Second, the drop in consumption has been larger and more sustained than in previous recessions. The drop in the 90-91 recession was nearly as large, but nowhere near as sustained as the present case.
Third, the time period when sustained consumption growth begins after the recession -- as indicated by the vertical arrows on the diagram -- varies by recession (there is some judgment involved in placing these arrows, e.g. the 80-81 arrow could be placed at the 5 month mark rather than at the 12 month mark, but the upward movement in consumption is much stronger after month 12). In addition, it is generally only after consumption has been fairly close to its pre-recession value for one or more time periods (i.e. somewhere near 1.0) that sustained growth begins. It's not clear, however, that returning to the pre-recession value is required for robust consumption growth to return.
This brings up two related questions about the path for real consumption from here forward (both of which are noted on the graph). First, real consumption has grown gently during months 17-23 (i.e. from May-October of this year), enough to make up some lost ground, but it's not clear how robust this growth is. It could be the beginning of a slow but sustained recovery for consumption, but consumption could sputter out and level off or even decline for some period of time, there's no way to tell at this point. My expectation is for slow, unsteady growth in consumption -- enough to eventually make up for lost ground and exceed pre-recession consumption -- but the growth will be slower and shakier than we saw before the trouble in the economy began, and this will continue for quite some time. The debt fueled increases in consumption we saw prior to the crisis will not be present going forward, at least not to the same, excessive degree, and this will constrain consumption growth in the future.
Second, and related to the first, how long until we return to the pre-recession level of consumption (1.0 on the graph)? If consumption growth continues at it present pace, 3 or 4 more months should be sufficient, though I expect it may take a bit longer than that. This is important because it has implications for when firms will begin to reach their pre-recession capacity levels. Once firms begin to reach capacity, further growth will require new investment, and restarting investment growth is a necessary part of the recovery process. Even after investment resumes, however, consumption growth is likely to be lower than before due to the decline in debt fueled consumption growth that was just mentioned.
Thus, at least for the immediate future and likely for much longer than that, slow consumption growth is expected. One way that could change is if the government implements a successful jobs program or uses some other means to increase household income (e.g. a payroll tax cut), and households spend rather than save the extra income (as, say, newly employed workers would be likely to do), but the political environment makes a jobs program or further fiscal policy action highly unlikely. Similarly, as Tim Duy recently noted, the Fed is anxious to unwind its massive policy intervention, not extend it, so monetary policy is unlikely to help much either. Since monetary and fiscal policy authorities are unwilling to provide further help, slow growth is the best outcome we're likely to get.
[Update: Ricard Green follows up with "Why it is hard to imagine consumption reigniting."]
