When the US economy moves into recession, does consumption increase, decrease, or stay the same?
The answer:
…it depends.
During periods of economic expansion, we observe that consumption levels steadily rise due to low unemployment rates and the growth of the average household's disposable income. But in a recession, the picture is not so clear. Consumers are more likely to cut back on elastic goods and services, such as eating out or purchasing a new car; furthermore, consumers are more likely to substitute out products of inelastic goods for cheaper alternatives, namely food & product brands. Thus, we would expect to see consumption to steadily fall during recessions as consumers cut back on spending habits due to slowing income growth and uncertainty about the labor market.
However, this is not the full picture. This summer, while working with Mike Aguilar, PhD to develop powerful Excel tools & charts for his upcoming macroeconomic courses in the Fall, we wanted to create event studies that track how major components of the economy move during periods of recession & periods of expansion. These charts are a powerful way of visualizing the movement of key parts of the economy during different phases of the business cycle and can provide valuable insights into understanding the forces that drive these movements.
From the attached event study chart, we see that consumption can move in multiple directions during a recession -- the 2001 recession, for example, saw consumption levels continue to rise likely due to aggressive interest rate cuts by the Federal Reserve and steady levels of retail sales. The most recent 2020 recession, on the other hand, saw consumption fall significantly at an unprecedented rate, falling over 10% after only two quarters, relative to the rate of consumption at the start of the recession. This significant drop was due to lockdown policies in response to COVID-19, which brought the economy to a standstill as businesses closed and consumers had to quarantine in their homes.
In other words, each recession is different from the last and poses its own unique problems. Tools such as monetary & fiscal policy can be used in an attempt to keep consumption high, but their effectiveness may be limited. These event study charts are a powerful tool for understanding the movement of key components of the economy so that we may learn from past recessions in order to help guide our policy-making for future ones.
To learn more about how I made this event study chart in Excel, or if you'd like to make your own, click on the link in the comments section below.
#macroeconomics #datascience #eventstudy #excel
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