How Recessions Affect Consumption

By Covering Business     March 15, 2012

Recessions take a significant toll on consumer spending. The most recent recession triggered the largest year-over-year drop in consumption since 1945, the year World War II ended.

The decline in consumption brought on by a recession is not only a function of a decline in disposable income. It’s also caused by consumers’ perceptions about their own wealth and how much they will make in the future.

Researchers from the National Bureau of Economic Research – more or less the official arbiter of recessions – studied the decline in consumption that accompanied the last recession, as well as its rebound. The researchers also examined how consumers’ perception of their own wealth and future income affected consumption. Here’s what they found:

• Consumption as a percentage of GDP declined more sharply during the last recession than during any recession since 1962.

• Over the last five years, personal consumption expenditures have grown at a rate of 0.8% a year, compared to a broader average of 3.1% a year from 1971 to today.

• After the recession ended, consumption did not return to pre-recession levels for almost three years, the longest recovery of any recession since 1962.

• The last recession had a particularly large impact on services consumption, relative to other recessions.

• Average expected income growth fell more sharply (and remained depressed for a longer period) during the last recession than during any recession of the last 30 years. Two and a half years after the nadir, expectations for income growth remained well off their pre-recession average.

• Americans with higher incomes and higher levels of education were more pessimistic in their income growth expectations during the last recession than those with lower incomes and lower levels of education. These differences more pronounced during this recession than during prior recessions.

• Americans’ income growth expectations have predictive power over their future income and their consumption. In other words, the mere prospect of slowing income growth weighs on spending.

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