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Why US Household Expenditures are Strong1

The Pros and Cons of Asset Price-dependent Spending Behavior

December 4, 2002
Makoto Minegishi*1
Hironori Ishizaki*2

  1. The opinions and viewpoints expressed in this paper are entirely those of the authors and do not necessarily reflect the official views of the Bank of Japan or the International Department. The authors wish to thank the Bank of Japan staff for the extremely valuable assistance rendered in the process of writing this paper and wish to acknowledge that any remaining faults in this paper are entirely those of the authors themselves.
  • *1Bank of Japan, International Department, Global Economic Research Division (now, Research and Statistics Department) (
  • *2Bank of Japan, International Department, Global Economic Research Division (

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  1. After a decade of expansion, the US economy entered recession in March 2001.
    What characterizes the latest recession more than anything else is the fact that corporate sector demand, as represented by capital investment, is undergoing a deeper correction than seen in past recessions, while household sector spending (consumption expenditures and housing investment) is unusually strong. Because of this, the recession itself has been extremely shallow.
  2. Household expenditures have maintained their strength during the latest recession primarily because of the rapid and large interest rate cuts enacted by the FRB. The impact of monetary easing went far beyond traditional interest rate-sensitive demand items like housing investment and automobile purchases to have a positive effect on household balances as a whole, increasing the value of the assets held by households and decreasing their interest burdens. Two factors were strongly at work in this in comparison to past easy money periods: 1) changes in the structure of the household balance sheet (rising percentages of interest rate-sensitive assets like stocks and homes, and increased borrowings), and 2) enhanced consumer financial services (better means of borrowing using homes as security, and easier refinancing of fixed interest mortgages).
  3. Verifications of the impact on households of monetary easing during the recession produced three conclusions: 1) demand increased for interest rate-sensitive goods such as homes and automobiles for which loans are traditionally relied on, and did so to keep pace with the decline in interest rates; 2) household interest burdens declined substantially because of a rapid increase in the refinancing of existing mortgages; and 3) falling interest rates combined with other factors to boost housing prices, which had a positive impact on consumer spending. Of these three conclusions the third route resulted in an overall decline in the assets owned by households because more cautious corporate earnings forecasts caused share prices to drop in spite of lower interest rates. However, due to the differences in the size of price fluctuations and the ownership of stocks and housing assets, there also tended to be differences in the degree of the wealth effect. In point of fact, the results from our consumption function estimate indicate that during the recession the positive wealth effect from the increase in housing assets was larger than the negative wealth effect from the decline in stock assets, and this likely had a positive effect overall.
  4. Having examined the increasing impact of interest rates and asset prices (particularly share prices and housing prices) on household expenditures, we go on to examine the "problems" of "low savings rates" and "excessive debt" that are often considered to be structural issues for US households. In particular, we examine the question of "low savings rates" and the downward bias in statistics due to the treatment of capital gains, an issue that has come to the fore of late. When corrections are made for this bias, it can be seen that the increase in owned assets due to past asset price rises decreases the need for new savings from current income, and this is linked to the decline in the savings rate. In other words, the decline in the savings rate and the increase in household debt themselves are the products of consumption and savings behaviors on the part of households responding to changes in the financial environment and do not necessarily contain, in themselves, factors for instability. At the same time, however, the other side of this trend is the increasing dependence of the household sector on the financial environment in general, and asset prices, in particular.
  5. The high dependence of the household sector on the financial environment contains several risks for future household expenditures: 1) the risk of downward pressure on consumption due to the overall wealth effect should stock price weakness be prolonged and eventually generate a negative wealth effect that is larger than the positive wealth effect from housing; 2) the risk that future housing prices will turn downward if there are bubble-like elements behind the housing price rises seen so far; and 3) the risk that household expenditures along with their balance sheets will rapidly deteriorate should interest rates rise and the mechanism examined in this paper work in reverse to exert a strong negative impact on household expenditures. It therefore behooves us to consider what would happen if these risks were realized. What changes would be seen in external balances and fiscal balances as a result of changes in the US household sector and the resulting movements on the capital markets? What impact would this correction have on the world economy as a whole? Strong household expenditures support both the US economy and the world economy and must therefore be watched carefully in the future.