Monday 04 July 2022

Expert updates

Household consumption: beware of nominal/real confusion 

Since the beginning of 2020, household consumption has been seriously disrupted, due to the temporary closure of certain sectors (especially services) and supply chain issues for certain types of goods, then the acceleration of prices. Monitoring the consumer spending and retail sales figures is much less easy than usual and it is more important than ever to distinguish between nominal and real when analyzing the figures.

Impressive consumption in nominal, but much less in real terms

In the United States, household consumption is particularly impressive when considered in nominal terms. Not only has it returned above its levels at the start of 2020, but it is even well above its pre-crisis trend. Retail sales (largely focused on consumption of goods) were 20% above the pre-crisis trend in May, which is very spectacular. Consumer spending (which includes consumption of goods but also of services) was just over 5% above its pre-crisis trend in April.

But given the very strong acceleration of inflation over the last 9 months, it is absolutely necessary to monitor the evolution of consumption in real terms. In fact, it is remarkable to note that real consumption fell sharply during the first phase of the covid crisis (from March 2020 to March 2021), which had been marked by the closure of many sectors of the economy, before coming back almost perfectly to its pre-crisis trend since March/April 2021. In other words, the "quantities" consumed returned from March 2021 to their pre-crisis trend.

There is therefore a particularly clear dichotomy between nominal consumption and real consumption, which can lead to errors of assessment. When we break down the deviation in nominal consumption into a "price" effect and a "quantity" effect, it emerges that nominal consumption fell below the pre-crisis trend from March 2020 to around March 2021 almost exclusively because of “quantity” effects (closed sectors, supply chain issues) then above the pre-crisis trend from March 2021 almost exclusively because of “price” effects. We can see that March 2021 corresponds both to a relaxation of health measures in the United States and to the adoption/implementation of Joe Biden's American Rescue Plan (new round of stimulus checks to households in particular).

Very marked sectoral distinctions

As we have just seen, real consumption in the United States has returned to its pre-crisis trend, but this masks an unprecedented distortion in the structure of consumption, since real consumption of durable and non-durable goods is still above its pre-crisis trend, while that of services is still clearly below. This “great distortion” of consumption during the covid crisis, in favor of goods over services, is completely unprecedented in these proportions when we consider long-term time series.

Over the past few months, we have seen a rebalancing of real consumption in favor of services and against goods. Real consumption of goods, while at high levels, has not grown at all in real terms for a year. Moreover, real retail sales are now even in sharp contraction year on year. For certain types of "premium" goods, rather reserved for high-end customers (such as jewellery, perfumery or pleasure boats and aircrafts), we note however that real consumption is not weakening, which could be linked to the fact that the richest 20% of households captured around two-thirds of the excess savings built up during the covid crisis.

Unlike goods, the consumption of services is still in a phase of rapid expansion, especially as some segments are still in the phase of reopening. For example, we can think of the entertainment sector (amusement parks, sporting events), subscription to gym centers or the hotel industry.

One of the important points to emphasize here is that there is naturally a certain degree of price elasticity: the higher the prices, the lower the quantities consumed. Here, we can remember that it is mainly the prices of goods that have increased in recent quarters. While the price of durable goods has fallen each year between 1995 and 2020, it has increased very sharply in recent months (peak at +11.5% year-on-year in January). Services inflation, which had always been higher than durable goods inflation since 1976, is now significantly lower. This rather atypical configuration from a historical point of view (and even unique in its magnitude) partly explains why the real consumption of goods is slowing (and even contracting) much more time than the real consumption of services.

In addition, this high inflation in the price of goods, by weighing on the quantities sold, is probably one of the elements behind the excess inventories recently observed in US supermarkets.

The very sharp acceleration in inflation over the past 9 months makes it even less relevant than usual to have a look only at nominal variables when analyzing household consumption. In the United States, household consumption is very spectacular when we consider it in nominal terms but much less when we consider it in real terms. Real consumption of goods has slowed sharply in recent months and is even flirting with contraction. The real consumption of services is still progressing rapidly, because the reopening of certain segments which were very penalized during the covid crisis has not yet been fully realized, but also because inflation in services is much lower than for goods, which is very atypical historically.

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By Bastien Drut, Chief Thematic Macro Strategist