Durable Goods and Consumption Durable Spending, Relative Prices and Consumption

Real annual consumption growth has averaged about 3.7% between 1998 Q1 and 2003 Q3—well above real average annual GDP growth of about 2.6% during that period. (2) Chart 1 shows that the buoyancy of consumer spending can be entirely accounted for by strong growth in durable and semi-durable goods expenditure (henceforth referred to as 'durable spending' unless otherwise specified). Since 1998 Q1 the annual growth rate of that spending has averaged 8.5%. In contrast, the growth of spending on other goods and services (which constitutes about three quarters of total consumer expenditure) has been much weaker, averaging 2.1% a year during that period. Chart 1 also shows that durable spending is volatile: it fluctuates more procyclically than non-durable spending. Periods of high GDP growth are accompanied by strong growth of durable spending relative to non-durable spending. And during recessions, durable expenditure typically falls back more sharply. This is consistent with economic theory which implies that households' purchases of durable goods could react more to economic news than households' demand for other goods and services. This is because durable goods provide a flow of services which households consume over a number of periods and those goods are typically purchased by households rather than rented. So, for example, given a perceived improvement in economic conditions (such as an increase in expected future income) households might seek to build up their stocks of those goods and therefore temporarily drive up their purchases of those goods relative to spending on other non-durable goods and services. An initial analysis might therefore wholly attribute the relative strength of durable spending in recent years to positive cyclical factors, which have caused households to increase their relative demand for durable goods. But the persistence of the strength of durable spending is puzzling. The gap between the annual growth rates of durable and non-durable expenditure has exceeded 4 percentage points in every quarter since 1998 Q3. That is unlikely to reflect short-run factors. Moreover, In real terms, the growth of durable spending has substantially outpaced that of spending on other goods and services since the mid-1990s. But that gap largely reflects the effects of falling relative prices: nominal spending on durables and on non-durables has grown at similar rates during that period. This article uses a simple framework to assess the behaviour of the real and nominal ratio of durables to non-durable spending in the long run. It also …