Another Look at Wealth and Consumption – Pt 1
Part 1 – Spending as a fraction of Net Worth
Tim Duy weighed in on the output gap debate – not my topic, but he presented this chart of net worth as a percentage of GDP.
That got me thinking again about the issue of whether consumption spending is determined by income or wealth. Specifically, if consumption is determined by wealth, there should be peaks in consumption corresponding to the dot-com and housing bubbles shown on Graph 1. However, as Graph 2 shows, there were no such peaks.
I’ve argued already that, contrary to standard economic thought, consumption is directly determined by income. (Posted at RB and at AB.) One observation was that consumption, as a fraction of income, didn’t vary much over time, averaging 90.1% with a standard deviation of 2.1%.
I took a similar look at consumption and net worth, data from Fred. The next three graphs show personal consumption expenditures (PCE) as a decimal fraction of net worth (blue, left scale) along with net worth (NW) (red, right scale) over different time spans.
Graph 3A spans from 1959 – the beginning of the data set – to 1979. Net worth rises exponentially as the population grows. Adjusting for population growth does not change the shape of the net worth curve, so, in the aggregate, we were becoming richer during those years. Note that PCE/NW follows a generally similar, though far bumpier trajectory. As I pointed out in the prior post, the personal savings rate also increased during this period, so the average worker was able to both save and spend more.
Graph 3B spans from 1975 to 1990. Net worth continues on its exponential track. But, after about 1979, PCE/NW drops, reversing the prior trend. By 1990, PCE/NW is no greater than it was in the early 1960’s. Meanwhile, the personal savings rate also dropped – to a range below that of the early 60’s.
Graph 3C spans from 1989 through October, 2011. The exponential growth of net worth falters before and during the two most recent recessions. After about 1994, PCE/NW is a roller coaster ride. Of particular interest is the exactly contrary motion at a detail level between NW and PCE/NW, after about 1998. During the housing bubble of mid-last decade, PCE/NW hit an all time low.
What narrative makes sense of these three graphs? Here’s my attempt.
Through the 60’s and 70’s, the standard of living was increasing, as incomes and net worth rose together. This allowed more discretionary spending, and therefore, the fraction of NW that was spent increased.
In the 80’s, aggregate net worth continued to rise, but consumption spending, quite dramatically, failed to keep pace. Lane Kenworthy has repeatedly pointed out that middle class income growth has decoupled from general economic growth as the upper income percentiles have captured an increasing slice of total income. As the wealthy grew wealthier and the middle class fell behind, the fraction of NW that was spent declined – exactly the opposite of what should happen if increasing wealth determined spending. But exactly what should happen if increased wealth is diverted to the already wealthy who have less of a propensity to consume.
During the 90’s, growth in median family income and GDP per capita were close to parallel (see graph at the Kenworthy link) so there was a lull in the decoupling. For most of that decade, PCE/NW was close to constant at 0.18-.19. But while spending was kept level, the personal savings rate continued to fall.
During the current century, median family income has flat-lined, while GDP/Capita has continued to increase. The decoupling has resumed and the wealth disparity has widened. During the two wealth bubbles, PCE/NW declined dramatically. When the bubbles burst and net worth declined, PCE/NW increased back into the 0.18-.19 range. Most strikingly, from about 1998 on, the two lines in graph 3C exhibit exactly contrary motion at a detail level.
Conclusions:
There was a tight relationship between Net Worth and consumption through the 60’s and the 70’s, when earnings growth kept up with GDP and wealth disparity was slight by current standards.
This relationship broke down during the 80’s – though one could argue as early as the mid 70’s – as aggregate wealth and working class income decoupled.
Most recently, the relationship between NW and PCE/NW is inverse. The big swings in NW that the bubbles provided also demonstrated that consumption spending does not depend on net worth.
As I indicated in the earlier post linked above, consumption spending does depend on disposable income, throughout the entire post war period. A simple look at readily available data casts grave doubts on the idea that wealth, and not income, determines consumption spending.
For the longer perspective, here is the data of Graphs 3 A-C on a single graph.
In part 2, we’ll look at how spending and Net Worth correlate.
Cross-posted at Retirement Blues.
I wonder if expectations of future wealth in the non-upper classes might be a useful way to look at it.
I say the non-upper classes because there are so many more of them, that smaller changes in expectations can yield big changes in aggregate consumption expenditures.
It perfectly describes my situation, adjusting my spending based on my optimism that my wealth will last until I die. (And in my thinking, income, as soon as it’s received, *is* principal.)
Those expectations are created by 1. Current wealth, and 2. Expecations of future income.
#2 is heavily determined by current income — the best predictor we’ve got of the future.
So yeah: current income is arguably the key driver of aggregate PCE, but that effect is mediated, to some extent, by how much that current income (plus other factors) affects people’s lifetime wealth expectations.
So this narrative:
In the sixties and early seventies people expected their net worth to grow. PCE/NW grew.
That was discouraged by stagflation. PCE/NW declined.
The early eighties comeback made them more optimistic. PCE/NW grew.
I don’t know what caused the decline in the late 80s. Did people perceive that the stock runup was falsish wealth (cf 1987 crash), didn’t perceive it as promising future wealth increases?
That story certainly makes sense to explain the decline during the dot-com era. People were getting wealthier, but they didn’t trust its staying power. With good reason. So the denominator grew but the numerator didn’t.
When their expectations were realized in 2000, the reverse happened: denominator declined and (again) numerator didn’t.
Ditto this century: purely denominator (financial-asset price) driven ratio changes. People simply don’t trust asset value changes as predictors of their future wealth, so they kept PCE the same while their so-called wealthy gyrated.
??
Steve –
Your narrative is coherent and fits the data presented here.
But you have to have a view that expectations are derived in a pretty sophisticated manner, if people can live in the dot-com bubble, but anticipate it ending in the short-medium term.
I just happen to have a huge skepticism about how expectations might or might not influence the average person’s spending behavior. My earlier linked post showed a strong correlation – in fact, nearly perfect – between spending and disposable income. That’s money in hand today, not an expectation about one, five, or ten years from now.
I think the typical person lives in a cash flow world, not an accumulated wealth world. Money is spent as one can afford to spend it (without going too much deeper into debt.)
That’s where most people are, since wealth disparity has been increasing since the 70’s
I’ll have more to say in follow up posts.
Cheers!
JzB
I have to agree with JzB. Consider 1974 was when rise in productivity and wages split such that wages no longer rose based on the rise or productivity. They rose less than. By 1978, using Saez’s data, 1978 was the low point of share of income for the top 1%.
So, we have had a growing economy, though ever slower over consecutive decades since the 80’s. We have increasing share of income to the top 1% and an ever greater capturing of the wealth (income converted to savings?) by the 1%.
This means if there was a phenomenon of spending based on future wealth, the portion of people who were in a financial position to express that thought process has been becoming an ever smaller number. I showed in my initial postings in 2007 that the only sector to have income stay even with GDP and inflation was the top 1%. That means a huge percentage was dropping out of that economic class that would have the option to express what Steve is suggesting.
Using trend lines, the trend of spending is clear in your 4th chart and coinsides with what I have said. Also, chart for having cunsumption cross below wealth in the mid 90’s is exactly as my 12/07 chart showed in my posting It’s the big one honey, I know it. 1996, the icome of the 99% fell below personal consumption. This had not happened since it crossed above to say in 1945.
The flattening of the late 80’s is simple: Savings and Loan. It was the test run of the real estate bubble we just popped. Same asset inflation. Same distruction of the middle class. Just not to this current degree. I’m betting it was enough to offset the declining share of income.
Also, bubble create jobs and rising incomes for more people than they create wealth. So, regardless of the 99% seeing some wealth increase do to the asset bubble, they are mostly seeing income rise and job security. I can easily imagine that rise of income and job opportunities creates a sense of security. That means spending. Unfortunately the joke is on them and the 99% get hurt. It is this population that has the greatest number of people economically destroyed. It happened for sure in the S & L real estate bubble.
If the masses understood wealth well enough to use it to anticipate ability to future spend, they would not have been harmed in such large numbers in a bubble.
Finally, lets not forget Krugers discussion and the Gatsby Curve. That is cool, but cooler was the estimated $440 billion of economic activity related to the $1.1 trillion of income shift to the top 1%. He noted that the shift did not mean we did not have the activity because people could have borrowed and “probably did” to make up for the shift.
Time for economist to stop thinking about an economy as if the vast majority knows and understands money well enough to think beyond cash in the hand today. They might actually come up with something useful that government could turn into beneficial public policy.
Jazzbumpa,
I’ve been scrutinizing another kind of decoupling: the supposed decoupling of economic growth from energy consumption as expressed in “energy intensity of GDP” and Kenworthy’s commentary led me to compare that decoupling with the productivity, median income decoupling LK (and EPI) looks at. Low and behold! The two decouplings are joined at the hip (GDP) and the composite picture is not pretty. See my “Unpacking the decoupling tautology”:
http://ecologicalheadstand.blogspot.ca/2012/03/unpacking-decoupling-tautology.html
The stalwart defense of growing income inequality has exposed the truth that economic growth is not actually the goal of conservatives. It is the commonest of common sense that income inequality leads to less growth. While conservativves go through the motions of defending the inequality by calling the top the producers and the bottom parasites they don’t actually really believe it. After all there have been zero new full time jobs created since the Bush tax cuts were enacted and population growth alone has demanded 12 million new jobs.
The issue with this topic is that non conservatives think this all is actually about economic growth but the real conservative project is a social one. That being to create a more agreeable, to them, social order.
The lynchpin of that order is a docile lower class. Or as John Hobo puts it.
“The thing that makes capitalism good, apparently, is not that it generates wealth more efficiently than other known economic engines. No, the thing that makes capitalism good is that, by forcing people to live precarious lives, it causes them to live in fear of losing everything and therefore to adopt – as fearful people will – a cowed and subservient posture: in a word, they behave ‘conservatively’. Of course, crouching to protect themselves and their loved ones from the eternal lash of risk precisely won’t preserve these workers from risk. But the point isn’t to induce a society-wide conformist crouch by way of making the workers safe and happy. The point is to induce a society-wide conformist crouch. Period. A solid foundaton is hereby laid for a desirable social order.”
http://examinedlife.typepad.com/johnbelle/2003/11/dead_right.html
Non conservatives can win this inequality means less growth issue every time but it won’t mean a thing because economic growth isn’t what this is about.