Consumption and Demand

During the recent economic downturn, anec dotal reports in the press indicate that some demands are recession resistant (beer) while others are very procyclical (e.g., wine). This naturally causes economists to attempt to infer something about Engel curves. Just as macroe conomists think differently about growth and business cycles, so it seems should microe conomists think differently about how con sumption responds to growth and business cycles. Using quarterly National Income and Product Account (NIPA) data, figure 1 depicts consumption and food expenditure growth. Mean percentage growth rates for food con sumption was 2.3% in the period 1948-1977 and 1.85% in the period 1978-2009 while the standard deviation of growth rates fell from 0.37 in the earlier period to 0.27 in the later pe riod. Consistent with Engel's law, the growth rate of food consumption has fallen over time (in either total or per capita forms). Unsur prisingly, the quarterly growth rate of medical consumption (not shown) is higher than food with a mean growth of 5.97% in the earlier period and reduced growth of 3.4% and de clining in the later period. Interestingly, stan dard deviation (d) of medical growth rate has fallen substantially from 0.51% to 0.18%. The mean growth of overall consumption expendi tures was 3.9% (d = 4.15 ) in the earlier period and 3.1 (d = 2.62) in the later period. Finally, housing expenditure growth rates (not shown) halved from 5.04% in the early period to 2.51 % in the latter period with very stable rates of growth (d = 0.15). However, negative growth rates occur during recessions (2001 is an ex ception). Indeed food expenditures fell almost 15% in the recent quarter from the previous quarter (which was also negative growth). Sim ilar patterns of negative growth rates during re cessions occur for the other two categories of consumption in the period 1978-2009 and for total consumption. As expected, consumption and consumption growth behave very differ ently in recessions. The question is: "Are the negative growth rates just due to a fall in cur rent income or do they reflect uncertainty?" If uncertainty is key, then one must funda mentally think about (model) future expecta tions in order to understand (measure) current demand. As simple as these basic Engel curve consid erations are, one of the liveliest debates in eco nomics centers on consumption in response to income. For decades, there has been the steady accumulation of evidence for and against a Keynesian-type view that people consume out of current income. The contrary view is most commonly called the permanent income hypothesis, or PIH, due to Modigliani and Brumberg (1954), Friedman (1957), and oth ers. Generally, forward looking intertemporal models of consumption and savings might be called the life-cycle hypothesis with PIH as a special case. Yet, economists have not been particularly successful at amassing convincing evidence that is consistent with the life-cycle model of behavior in all of its ramifications. And, many find models of conventionally ra tional economic agents wanting (e.g., Laibson 1998). The PIH is that individuals consume out of an annuity derived from expected lifetime wealth. This is particularly relevant when dis cussing the effects of countercyclical fiscal pol icy. John Taylor (2008) recently sided with the PIH against the Keynesian or neo-Keynesian view. A second major issue is whether liquid ity constraints mitigate the forward looking life-cycle predictions. A third issue is how un certainty affects consumption and saving (pre cautionary) behavior. Much research has focused on the demand response to changes in total expenditure (or even food expenditure allocations to particu lar foods). Engel curve notions of this research could be stated as dqt/dc (/ = 1,..., n) where c is real total consumption expenditures, c = J2?=i PiQi where qt and pt are the /th quantity and real price, respectively. Macroeconomics Fellows Address. Rulon D. Pope is professor of Economics at Brigham Young University. The author would like to thank Daniel Sullivan for assistance. Fellows Address was presented at the 2008 AAEA annual meet ing in Milwaukee, WI, August 2009. Invited addresses are not sub jected to the journal's standard refereeing process.