America s Changing Tastes Income Growth and the Impact of Relative Price Changes on Age-based Consumption Patterns Income Growth

Similar documents
ECONOMIC COMMENTARY. Wage Growth after the Great Recession Roberto Pinheiro and Meifeng Yang

ECONOMIC COMMENTARY. Labor s Declining Share of Income and Rising Inequality. Margaret Jacobson and Filippo Occhino

ECONOMIC COMMENTARY. Americans Cut Their Debt Yuliya Demyanyk and Matthew Koepke

Which Estimates of Metropolitan-Area Jobs Growth Should We Trust?

ECONOMIC COMMENTARY. When Might the Federal Funds Rate Lift Off? Edward S. Knotek II and Saeed Zaman

ECONOMIC COMMENTARY. Income Inequality Matters, but Mobility Is Just as Important. Daniel R. Carroll and Anne Chen

Productivity Growth and Real Interest Rates in the Long Run

ECONOMIC COMMENTARY. Unemployment after the Recession: A New Natural Rate? Murat Tasci and Saeed Zaman

Labor Market Tightness across the United States since the Great Recession

Out of the Shadows: Projected Levels for Future REO Inventory

The Evolution of Household Leverage During the Recovery

Debt in Norwegian households within a life-cycle perspective: an analysis using household-level data

What the Consumer Expenditure Survey Tells us about Mortgage Instruments Before and After the Housing Collapse

Looking Back at Slow Employment Growth

How Credible are Capital Spending Surveys as Forecasts?

Philip Lowe: Changing patterns in household saving and spending

A Closer Look at U.S. Economic Weakness

CEPR CENTER FOR ECONOMIC AND POLICY RESEARCH

AUGUST THE DUNNING REPORT: DIMENSIONS OF CORE HOUSING NEED IN CANADA Second Edition

Stuck in the Great Recession s Income Slump: Sluggish Job Earnings Impede an Economic Expansion

ECONOMIC COMMENTARY. Not Your Father s Recovery? Kenneth R. Beauchemin. Figure 1. The Severity of the Recession and the Strength of the Recovery

Household Healthcare Spending in 2014

Rocky Mountain ECONOMIST: Labor force participation rates have fallen sharply THE

ECONOMIC COMMENTARY. An Unstable Okun s Law, Not the Best Rule of Thumb. Brent Meyer and Murat Tasci

The Index Leading Indicators

The Productivity to Paycheck Gap: What the Data Show

Michigan Consumer Sentiment: August Final Remains Low

THE FINANCIAL SITUATIONS OF OLDER ADULTS

Issue Number 51 July A publication of External Affairs Corporate Research

Measuring Total Employment: Are a Few Million Workers Important?

20 Years of School Funding Post-DeRolph Ohio Education Policy Institute August 2018

Table 1 Annual Median Income of Households by Age, Selected Years 1995 to Median Income in 2008 Dollars 1

o. "n August 5, the U.S. Senate cleared

Banking and the Flow of Funds: Are Banks Losing Market Share?

District Economic. Structurally Deficient Bridges, 2001 (Percent)

The Changing UK Labour Market for Young People: Trends Since Yi Zhang Low Pay Commission

The Concept and Measurement of Asset Poverty: Levels, Trends and Composition for the U. S., Robert Haveman and Edward N.

Socio-economic Series Changes in Household Net Worth in Canada:

INCOME AND EXPENDITURE: PHILIPPINES. Euromonitor International March 2015

Calculator $129 $129. Median family Income $ 12,909 $ 59,500. Calc cost as % of income 1% 0.2%

International Journal of Business and Economic Development Vol. 4 Number 1 March 2016

2 TRENDS IN THE DISTRIBUTION OF HOUSEHOLD INCOME BETWEEN 1979 AND 27 Summary Figure 1. Growth in Real After-Tax Income from 1979 to L

SPECIAL REPORT. TD Economics CONDITIONS ARE RIPE FOR AMERICAN CONSUMERS TO LEAD ECONOMIC GROWTH

Adults in Their Late 30s Most Concerned More Americans Worry about Financing Retirement

Quarterly General Fund Revenue Report JANUARY 2017 BARRY BOARDMAN, PH.D.

Recent Trends in Household Wealth, : the Irresistible Rise of Household Debt

Indiana Lags United States in Per Capita Income

ECONOMIC COMMENTARY. Have Inflation Dynamics Changed? Edward S. Knotek II and Saeed Zaman

March 2008 Third District Housing Market Conditions Nathan Brownback

Volume Title: The Formation and Stocks of Total Capital. Volume URL:

ECONOMIC COMMENTARY. Three Myths about Peer-to-Peer Loans. Yuliya Demyanyk, Elena Loutskina, and Daniel Kolliner

Data Dependence and U.S. Monetary Policy. Remarks by. Richard H. Clarida. Vice Chairman. Board of Governors of the Federal Reserve System

ECONOMIC COMMENTARY. Reassessing the Effects of Extending Unemployment Insurance Benefits Pedro Amaral and Jessica Ice

Growing Slowly, Getting Older:*

Retirement Insecurity The Income Shortfalls Awaiting the Soon-to-Retire

Eleventh District Banking Industry Weathers Financial Storms

Do Bank Branches Matter Anymore?

district highlights The New York New Jersey Job Recovery James Orr and Rae D. Rosen Note from the Editor Volume 3 Number 12 October 1997

CONTENTS. The National Outlook 3. Regional Economic Indicators 5. (Quarterly Focus) Volunteer Labor in Missouri

Retirement in review: A look at 2012 defined contribution participant experience*

Savings Rate Lowest In A Decade, Credit Card Balances Soar

Data Brief. Dangerous Trends: The Growth of Debt in the U.S. Economy

Normalizing Monetary Policy

Monitoring the Performance of the South African Labour Market

THE STATE OF AMERICA

PERSONAL EXPENDITURES OF AMERICANS

of the city. District 4 had the largest population of 18- through 24-year-olds (college-age Salt Lake City 2000 Population

Historical Effective Tax Rates, Preliminary Edition

Briefing Paper. Business Week Restates the Nineties. By Dean Baker. April 22, 2002

The impact of negative equity housing on private consumption: HK Evidence

Maine s Labor Market Recovery: Far From Complete by Joel Johnson and Garrett Martin

Monitoring the Performance of the South African Labour Market

Georgia Per Capita Income: Identifying the Factors Contributing to the Growing Income Gap with Other States

IRA Withdrawals in 2013 and Longitudinal Results , p. 2

ECON 314: MACROECONOMICS II CONSUMPTION AND CONSUMER EXPENDITURE

file:///c:/users/cathy/appdata/local/microsoft/windows/temporary Int...

Weakness in the U.S. Housing Market Likely to Persist in 2008

Notes and Definitions Numbers in the text, tables, and figures may not add up to totals because of rounding. Dollar amounts are generally rounded to t

How were Lebanese Households Allocating Their Pay checks in 2012?

Current Economic Conditions and Selected Forecasts

Women Leading UK Employment Boom

Recession Dating and Real-Time Data * Calvin Price June 2008

Quarterly Labour Market Report. December 2016

FRBSF ECONOMIC LETTER

The Economic Downturn and Changes in Health Insurance Coverage, John Holahan & Arunabh Ghosh The Urban Institute September 2004

e-brief What s My METR? Marginal Effective Tax Rates Are Down But Not for Everyone: The Ontario Case April 27, 2011

Changes in Japanese Wage Structure and the Effect on Wage Growth since Preliminary Draft Report July 30, Chris Sparks

Equality in Job Loss:

THE ECONOMY IN 2017: BETTER, BUT WORSE!

An Overview of the Clinton Budget Plan

cepr Analysis of the Upcoming Release of 2003 Data on Income, Poverty, and Health Insurance Data Brief Paper Heather Boushey 1 August 2004

Incomes and inequality: the last decade and the next parliament

The state of the nation s Housing 2013

Labor Force Participation Rates by Age and Gender and the Age and Gender Composition of the U.S. Civilian Labor Force and Adult Population

Monthly Bulletin of Economic Trends: Households and Household Saving

HOUSEHOLD EXPENDITURE IN MALTA AND THE RPI INFLATION BASKET

DEMOGRAPHIC DRIVERS. Household growth is picking up pace. With more. than a million young foreign-born adults arriving

Economic Standard of Living

Tracking Report. Trends in U.S. Health Insurance Coverage, PUBLIC INSURANCE COVERAGE GAIN OFFSETS SIGNIFICANT EMPLOYER COVERAGE DECLINE

Health Insurance Coverage in 2013: Gains in Public Coverage Continue to Offset Loss of Private Insurance

Transcription:

ECONOMIC COMMENTARY Number 215-8 July 9, 215 America s Changing Tastes Income Growth and the Impact of Relative Price Changes on Age-based Consumption Patterns LaVaughn Henry This analysis shows that age-based consumption profi les have been affected by differences in the growth rates of real income and prices since the onset of the Great Recession in 28. In particular, it shows that the recession caused changes in both the absolute level of households consumption as well as the relative shares of income going to purchase necessities and luxuries, and that these changes differed by age group. It also shows that this shift occurred in spite of higher rates of price infl ation for necessity goods relative to luxury items. Economic researchers have long documented the relationship between age and patterns of consumption. In the standard model of saving and consumption, individuals borrow when they are young, save as they approach and live through middle age, and dis-save when they are old (Modigliani and Brumberg, 1954; Ando and Modigliani, 1963). It is generally assumed that households with higher incomes and accumulated wealth will allocate a greater share of their disposable income to luxury consumption, relative to less wealthy households. Older age groups generally have higher levels of income and wealth and thus are more likely to be associated with greater degrees of luxury consumption than younger groups. 1 During the Great Recession, income fell for most age groups, though by varying degrees. This analysis measures the impact of those decreases on the consumption habits of different age groups. 2 In particular, it shows that the recession caused changes in both the absolute level of households consumption as well as the relative shares of income going to purchase necessities and luxuries, and these changes differed by age group. It also shows that this shift occurred in spite of higher rates of price inflation for necessity goods relative to luxury items. Income Growth To gain insight into changes in real income and consumption patterns across different age groups, we explore data from the Bureau of Labor Statistics annual Consumer Expenditure Survey (CES). The CES program consists of two surveys, conducted on an annual basis since 1984, which provide information on the buying habits of American consumers. CES data on income and consumption is provided in terms of consumer units. These consumer units parallel households for most purposes and thus will be referred to as households throughout this analysis. 3 Households are divided into six age groups, determined by the age of the owner or renter of the housing unit: 16-24, 25-34, 35-44, 45-54, 55-64, and 65 and older. 4 After adjusting the data for inflation, 5 we see that all age groups experienced growth in their real incomes to differing degrees from 2 to 27, and then, with the exception of the oldest group, real incomes fell between 27 and 213 (figures 1 and 2). The greatest decline occurred in the youngest age group, those under 25 years old. Across all age groups, real pretax incomes rose at an average annualized rate of 2.4 percent in the pre-recession period and declined 1.5 percent in the recession and recovery period. With such large income changes, it is reasonable to expect that a significant change in consumption spending and composition also occurred. ISSN 428-1276

Changing Levels and Types of Consumption Changes in consumption patterns can be caused by myriad factors, but one way of thinking about them is in terms of what economists call income and substitution effects. The income effect refers to the fact that as households incomes rise, their consumption increases (up to a point of satiation), while the substitution effect states that households consumption patterns are affected by changes in the relative prices of goods. As prices rise for a given good, relative to the price of a substitutable good that provides a comparable level of satisfaction, households will switch to the less costly good when possible. These effects, either in whole or in part, may help explain the shifts in consumption patterns that have occurred across age groups. Households also can reorder their consumption profiles based on the character of the good or service that is to be consumed. Specifically, households may change how much of a good or service they buy as their incomes and prices change, depending on whether they consider it a luxury or a necessity. In economics, a luxury item is a good or service for which demand increases more than proportionally as income rises. Necessity goods, by contrast, are goods for which demand increases proportionally less as income increases. The income effect would imply that to the extent possible, households will spend a greater share of their income on luxuries as their income increases and less on necessities. Age factors into the picture such that, as people grow older and their wealth increases, a greater share of their income goes toward the purchase of luxury items (table 1). The substitution effect also has implications for the shares of luxury and necessity items consumed. Necessities are goods and services that households consider indispensable and will not likely cut back on even when times are tough. Examples of such items might include food, electricity, water, gas, and even technology such as cell phones and computers. The more necessary a good is, the less responsive its price is to increases in demand for the good, as people will attempt to buy it no matter the price. If prices are rising, a greater share of a household s income may end up going to these necessity goods and services, if households are not able to substitute away from them due to a lack of appropriate alternatives. Looking again to the CES data, we see that overall consumption has followed changes in income over the Great Recession and recovery. From 2 to 27, expenditures grew between 2.1 and 4.1 percent for all age groups (figure 3). Once the recession hit and up through 213, consumption growth fell drastically for all but the oldest age group (though it still fell for them as well). The Effect of the Recession on the Consumption of Luxuries and Necessities The consumption data from the CES is recorded in terms of 23 categories of expenditures. We can use these categories to identify changes in the proportions of luxuries and necessities consumed in the different age groups. To do so, each of the 23 categories is classified as a luxury or necessity using a system where luxuries are defined as items that are consumed more, on a percentage basis, as real income levels increase (that is, going from lower to higher income quintiles), and necessities Figure 1. Annualized Growth in Real Before-Tax Income Figure 2. Average Annual Real Before-Tax Income 5 2-27 27-213 Thousands of dollars 9 4 3 2 1 8 7 6 5 4 45 to 54 35 to 44 55 to 64 25 to 34 65 and over -1-2 3 2 Under 25-3 1-4 All age groups Under 25 25-34 35-44 45-54 55-64 65 and over 2 22 24 26 28 21 212

are defined as items that account for a smaller percentage of consumption as real income levels increase (for detail, see Henry, 214). 6 A category is classified as indeterminate if no discernible pattern emerges as income level increases. Using this method to sort the data into luxury and necessity categories reveals that for households in general, the proportion of income going to the consumption of necessities declined from 2 to 27, dropping from 39.5 to 35.1 percent. This again corresponded to a period where households saw rising rates of income growth. However, with the onset of the recession in 28, the trend reversed, mirroring the trend for income growth, and the share of necessities purchased rose to 37.3 percent of total consumption by 213. Meanwhile, the average consumption share for items classified as luxuries declined only slightly over the entire time period, from 56. to 55. percent. However, this was mainly accounted for by constancy in the older age categories, which largely offset the decline in real luxury consumption among younger age groups. The data also shows how the consumption of luxuries and necessities varies greatly by age group, and it shows that the recession affected different age groups to lesser or greater degrees. In table 1, one can see that luxury items account for a greater share of the average household s market basket for those at least 25 and older. In accordance with the income effect, as income levels increased (being proxied for by the successive age groups) luxury consumption became more resistant to decline during the recession and recovery period. Declines in the consumption of luxury items did occur for all age groups during this period with the exception of the oldest, which experienced a marginal increase of.9 percentage points in the share of their consumption going to luxury items. Necessity consumption also declined for many but not all age groups during the recession and recovery period. However, the relative percentage allocated toward necessity consumption declined much less for all age groups relative to the magnitude of the luxury share decline. Inflation for Luxuries and Necessities Between 2 and 213, the prices of the goods and services used in this analysis, as measured by the Bureau of Economic Analysis s Personal Consumption Expenditures Index, rose at an average rate of 2.9 percent annually. But luxury and necessity items were not affected equally (figure 4). Price growth for luxuries over the entire period was 1.9 percent, half that of necessities, 3.8 percent. In the prerecession period, price growth was even more divergent: 2.2 percent for luxuries and 4.7 percent for necessities. However, even up through 213 the growth of necessity prices (2.7 percent) still exceeded that of luxury prices (1.5 percent). (See figure 5.) Given the substitution effect, one should expect to see a shift toward luxury consumption during both periods and away from necessity consumption. However, the data does not demonstrate this. What it does show is that while the share of income going toward luxury consumption did increase in the pre-recession period, the share going toward necessity consumption in the recession and recovery period was the most resistant to change, despite higher rates of price growth for necessities. Households sought to maintain, to the best Table 1. Relative age of Average Consumption by Age Group of Necessity and Luxury Goods Figure 3. Annualized Growth in Real Expenditures All Age Under 25 25-34 35-44 45-54 55-64 65 and older Necessity goods 2-27 37.5 5.5 37.8 34.5 35.3 35.3 45. 28-213 36.7 49.1 37.6 34. 34.7 34. 41.4 Luxury goods 2-27 57.1 44. 56.2 59.9 59.3 59.1 5.9 28-213 55.9 41.7 53.8 57.9 57.5 58.3 51.8 Indeterminate goods 2-27 4.9 5.5 6.1 5.6 5.4 5.6 4.1 28-213 4.6 9.2 8.6 8.1 7.8 7.8 6.7 4.5 4. 3.5 3. 2.5 2. 1.5 1..5. -.5 All age groups 2-27 27-213 Under 25 25-34 35-44 45-54 55-64 65 and over Note the data are adjusted for infl ation.

of their abilities, their consumption of necessity items while sacrificing luxury items, during and following the economic downturn. These results speak to the dominant impact that the income effect had relative to the substitution effect in driving consumption trends between the two periods. Implications The changes in the relative consumption shares of necessities and luxuries before and after the recession were reinforced by the disparate growth rates of income in different age groups, as well as stronger rates of growth in the prices of necessity goods relative to luxuries. These changes had a greater impact on younger households, as they consume a greater percentage of necessity goods than older households and they generally have lower income and wealth resources to support the consumption of luxury goods during an economic downturn. Income growth has been stagnant for most sectors of the American population since the turn of the century. All age groups saw declines, or stagnancy, in their income growth rates and adjusted their consumption ratios of necessity to luxury goods. Younger people were the most affected by slow income growth and the rising prices of necessity goods. During the recovery period, people 44 and younger increased their consumption of necessities relative to luxuries. Middle-aged people, 44-54, were the most invariant, holding their consumption mix relatively stable relative to the pre-recession period, while those 55 and older were the most likely to continue increasing the percentage of their income allocated to luxury consumption. These outcomes bear consideration because the oldest age groups were most likely bearing a large part of the burden of lower interest rates, given that a larger portion of their income is dependent on interest income. For example, according to the Consumer Expenditure Survey, in 213 people 65 and older received approximately 13 times the amount of interest and dividend income as people 24 and younger. Additionally, the presence of income stabilizers such as Social Security and pensions makes older groups more invariant to economic shocks that would otherwise cause them to reduce or change their consumption patterns. It should also be noted that these trends are in stark contrast to the long-term trend that typified the reduction of necessity consumption across all age groups prior to the recession. The degree to which this development is or will become permanent has yet to become obvious, but if it were to become permanent it could materially impact production patterns in the future. For example, people aged 25-44, the prime age group at which Americans normally purchase their first home, decreased the relative percentage of their income going to purchase owned dwellings, a luxury good, by an average of.8 percent between 28 and 213, relative to the 2-27 period. Similarly, this group s consumption of the relative necessity, rented dwellings, rose by 1. percent in the post-27 period. Such movement is consistent with the resurgence in multifamily construction and the relative weakness in singlefamily construction that has been observed over a similar period. Continued weak growth in housing construction, due to this and other factors, would directly lessen the nation s potential future GDP growth. Figure 4. Annualized Growth Rate in Prices of Luxury and Necessity Items Figure 5. Relative Rates of Annual Price Growth Luxuries Necessities 8 6 4 2-2 -4 2 1 2 3 4 5 6 7 8 9 1 11 12 13 5 4 3 2 1-1 -2-3 -4-5 -6 All age groups 2-27 luxuries 28-213 luxuries 2-27 necessities 28-213 necessities Under 25 25-34 35-44 45-54 55-64 65 and over

Footnotes 1. According to the Federal Reserve s 213 Survey of Consumer Finances, median family net worth rose significantly as the age of the household head increased. For example, families with household heads 35 and younger had a median net worth in 213 of $1,4. For households with heads aged 65-74, the peak age group for this measure, it was $232,1. 2. For purposes of this analysis, age group is defined as the age of the first household member mentioned by a respondent answering the question Start with the name of the person or one of the persons who owns or rents the home, in the Bureau of Labor Statistics Consumer Economics Survey. 3. A consumer unit consists of any of the following: (1) All members of a particular household who are related by blood, marriage, adoption, or other legal arrangements; (2) a person living alone or sharing a household with others or living as a roomer in a private home or lodging house or in permanent living quarters in a hotel or motel, but who is financially independent; or (3) two or more persons living together who use their incomes to make joint expenditure decisions. The reference person of the consumer unit is the first member mentioned by the respondent when asked to Start with the name of the person or one of the persons who owns or rents the home. It is with respect to this person that the relationship of the other consumer unit members is determined. 4. While it is often useful to look at individuals incomes, many consumption decisions are shared across a household. 5. Data were adjusted for inflation using the Bureau of Economic Analysis s Personal Consumption Expenditures Index. The historical price series was used. All price-related references in the analysis relate to 29 price levels. 6. Category-specific results of the relative consumption percentages are provided in Henry, 214. References Ando, Albert, and Franco Modigliani, 1963, The Life-Cycle Hypothesis of Saving: Aggregate Implications and Tests, American Economic Review, 53(1), 55 84. Henry, LaVaughn, 214. Consumer Spending Reflects New Priorities after the Recession Economic Commentary, 214-18. Modigliani, Franco, and Richard H. Brumberg, 1954, Utility Analysis and the Consumption Function: An Interpretation of Cross-section Data, in Kenneth K. Kurihara, ed., Post-Keynesian Economics, New Brunswick, NJ. Rutgers University Press, pp. 388 436.

Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 4411 PRSRT STD U.S. Postage Paid Cleveland, OH Permit No. 385 Return Service Requested: Please send corrected mailing label to the above address. Material may be reprinted if the source is credited. Please send copies of reprinted material to the editor at the address above. LaVaughn Henry is vice president and senior regional offi cer of the Cincinnati Branch of the Federal Reserve Bank of Cleveland. The views he expresses here are his and not necessarily those of the Federal Reserve Bank of Cleveland, the Board of Governors of the Federal Reserve System, or Board staff. Economic Commentary is published by the Research Department of the Federal Reserve Bank of Cleveland. To receive copies or be placed on the mailing list, e-mail your request to 4d.subscriptions@clev.frb.org or fax it to 216.579.35. Economic Commentary is also available on the Cleveland Fed s Web site at www.clevelandfed.org/research.