Consumer Spending and Recession

How much is consumer spending likely to fall as a consequence of stock and home price declines? If we assume a $10 trillion decline in housing and equity wealth, and a wealth effect of .04, we arrive at a decline in consumer spending of $400 billion. So, roughly 2-3 percent of GDP.

Even if we get the financial crisis fixed, we can expect a serious recession.



The figure (click for larger version) is from this 2005 paper by Case, Quigley and Shiller. Their analysis suggests a (housing) wealth effect of about .04

Comments

[John Preston:]

Well, I have been using this study for some time now, about a year and a half.....the study and related testimony before the FED are interesting as these are respected and quoted economists and their work and warnings were ignored......had the FED and others listened earlier, repairing housing could have stabilized the economy.

The longer it takes for those in charge to realize that the consumer may get comfortable in not consuming, the worse this will get.

2008 Nov 10 08:18 AM

[Warren S.:]

Assume consumer spending bumps up temporarily for the holiday shopping season as consumers get creative with their budgets. One such plan is to do all holiday shopping online at sites like Sortprice.com and keep the car at home.

www.sortprice.com/

sortprice.com

2008 Nov 10 10:39 AM

[jstratt:]

I suggest additional factors will play a role in consumer spending beyond this housing effect which is important.

1) Their arent going to be many buyers in the next year for securitized credit card debt. In Oct it was reported that 1 deal for 50 bil occurred which was a 99% reduction in credit card funding from the previous Oct. The means that going forward additional credit card lending will take a huge drop. Who wants to lend capital to overextended consumers in a recession with rising unemployment?

My point is that it is no longer just a consumer decision. It is a capital provider decision. Those who still have capital to lend know how to say NO! They also know how cut off any remaining available credit.

2) The biggest consumers in the last year have lost by my calculation 40% - 100% of their equity. Many of these are people with good jobs and strong income. Unfortunately they have huge debt. If they are a big consumer they will have at least 50% debt to assets on average. So take that 20% drop in asset values and multiply it by 2 for a 40% drop in their Net Worth. If they had 75% debt to assets which is not uncommon they may well not have any remaining Net Worth.

Assets 200k 160k
Debt 100k 100k
------- ------
Net Worth 100k 60k Ouch! a 40% drop makes anyone feel poor!

2008 Nov 10 06:52 PM