Home > Uncategorized > Shocking! Breaking! Young economists discover that lower income leads to lower consumption!

Shocking! Breaking! Young economists discover that lower income leads to lower consumption!

We are living in a dark age of macro-economics indeed.

The empirical record of the last 300 years: (ultra-)unemployment in combination with wage cuts will lead to (much) lower incomes of households which leads to (much) lower expenditure of households. Recently, this has been happening for three or four or five years in a stretch, in countries like the Baltics and Ireland and Greece and Italy and Portugal and Spain and which is happening increasingly in the Netherlands and which will happen soon in Finland, too. Higher unemployemt in combination with lower incomes causes people to  tighten their belts, which leads to a further decline of expenditure and a positive multiplier.

But on Voxeu, Petra Gerlach-Kirsten, Rosanna Merola and Connor O’Toole discover that lower household income leads to lower household expenditures. Which is puzzling to them as non-monetary rational consumer general equilibrium models had led them to believe that lower incomes do not lead to lower expenditure. Because rational households in an ergodic world know their future incomes and smooth consumption, taking their future incomes, future interest rates and future ideas and preferences into account when spending today, while they are also not cash constrained:

“We find that consumption growth is lower during financial crises, particularly during banking crises, and that a drop in income reduces consumption in the short run.”

Arghhh… we are not talking about lower growth here, we are talking about unimaginable drops of 30 to 40% in some countries. A single look at the national accounts will show their second point and would have shown that five, ten, fifteen and twenty years ago. And they do not even mention unemployment.

This line of reasoning is of course influenced by the ideas of people like Milton Friedman who mixed up non-monetary consumption (i.e. the use of consumer goods) and ‘utility’ with monetary consumption (i.e. the purchase of consumer goods) and production, to argue that consumption was non-cyclical, signifying that all kinds of counter-cyclical government policies were not necessary. But monetary consumption is cyclical and contrary to the statements of Gerlach-Kirsten, Merola and O’Toole it has been quite cyclical all along, especially expenditure on consumer durables. In the real world, the smoothing of the use of these durables leads to more cyclical purchases!

Dear friends, if post war consumption did not show the large cyclical developments of the past this was because incomes were smoothed by automatic stabilizers, minimum, wages, whatever, and not because households smoothed expenditures. However – governments have given up on this, at least in the EU, and ultra-unemployment (oops, ultra-unemployment is not even mentioned in their article…) and volatile expenditure are back, together with highly volatile consumer expenditures.

I agree, however, with their point that household heterogeneity should be taken into account – there is a difference between wealthy and poor households.

  1. Herb Wiseman
    December 1, 2013 at 2:38 pm

    Duh! Heard a talk radio programme the other day about energy costs. People called in to say that they sometimes had to choose between paying the rent and electric vs. buying food! Guess they never heard of Friedman models of consumption and spending.

  2. sergio
    December 1, 2013 at 2:50 pm

    For neoclassical economists that would mean that lower consumption means higher savings and therefore lower income leads to higher savings! Which is good for long-run growth!
    Earn less, consume less, save more and you will be richer. Invest your savings in human capital – buy our textbooks Principles of Economics and your productivity will increase.

    Just three questions. 1. Who will produce for workers with low income? 2. When will savings become consumption? 3. Why inflation is high in times when income is lower or in times of high unemployment?

  3. Paul Schächterle
    December 1, 2013 at 3:07 pm

    I feel your pain. Economics is in a very sad state, indeed.
    I guess we have to be happy that mainstream economists are no longer able to ignore reality completely.

  4. BFWR
    December 1, 2013 at 7:35 pm

    I’m on board with economic weather forecasting….if the individual AND the system are BOTH set free by a sufficient universal dividend and compensated retail discount. There is only freedom amongst barriers in the temporal universe and uncertainty is only a burden for the neurotic….or the powerful who are currently in “control”. But I repeat myself.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: