Consumption of durable goods in the euro area

Prepared by André Casalis and Georgi Krustev

Published as part of the ECB Economic Bulletin, Issue 5/2020.

1 Introduction

Trends in households’ purchases of durable goods have important implications for the business cycle, which motivates the need to examine them closely from a monetary policy perspective. First, because of their marked pro-cyclicality, durables can help in tracking – and possibly anticipating – the state of the business cycle in the euro area, thus complementing the signal from other pro-cyclical demand components, such as investment.^[1] Second, expenditure on durables can help us better understand cross-country heterogeneity in terms of consumption and saving habits, as well as its drivers. Third, since purchases of durables can be financed using credit, the behaviour of durable goods provides important insights into the state of financing conditions in the economy.

Expenditure on durable goods is a key component of consumption dynamics, despite accounting for a modest share in aggregate household spending. In the two years preceding the coronavirus (COVID-19) pandemic that has affected the European and global economies, annual growth in euro area consumption moderated from the solid rates of expansion observed in 2015-17, partly owing to a decline in spending on durable goods (see Chart 1). Specifically, having provided strong support to the earlier phases of the latest expansion, durables accounted for almost one-third of the overall loss in growth momentum in consumption in 2018-19, despite amounting to less than 10% of its total share.^[2]

Consumer durables have specific characteristics that set them apart from other consumption expenditure items. First, a durable good provides utility over multiple periods and (like capital) is subject to depreciation. This allows consumers to postpone purchases in times of economic hardship, while still benefiting from the flow of services from the accumulated stock, and to adjust to the desired level of durables once the economy has recovered.^[3] Secondly, the purchase of durables can often be financed using credit and the durables are sometimes eligible for use as collateral, which can make them more exposed to credit conditions and lending rates than non-durables.^[4] Finally, changes in the stock of durables may be subject to adjustment costs. This could lead to sluggish and protracted cycles in durable goods expenditure, since the presence of such costs determines “inaction zones” where a consumer finds it optimal not to adjust small differences between the actual and the desired stock of durables.^[5] Box 1 provides further details on the statistical features of durable goods consumption data in the euro area.

Against this background, this article takes a longer-term perspective to explore stylised facts about expenditure on durables in the euro area and its relevance for business cycle fluctuations. Section 2 describes the characteristics and behaviour of durable goods consumption over the business cycle. Section 3 covers the relevance of financing conditions, including a specific focus on car purchases. Section 4 deals with long-run trends in relative prices and shares of durable goods in consumption. The analysis is complemented by insights from an empirical (structural VAR) model in Section 5, which decomposes consumption growth into structural shock contributions, distinguishing aggregate demand and supply shocks from durable-specific ones, while taking into account monetary conditions.

2 Behaviour and characteristics of durable goods consumption

2.1 Cyclical behaviour of durables

Expenditure on durables tends to be volatile and pro-cyclical, reflecting the specific characteristics of this type of good. As shown in Chart 2, the dynamics of year-on-year durable goods consumption exhibit ample fluctuations, with growth typically exceeding GDP (and non-durable goods consumption) in times of economic expansion and contracting more strongly during recessions. The pro-cyclicality of expenditure on durable goods was particularly pronounced in Italy and Spain during the European sovereign debt crisis. The counter-cyclical behaviour in Germany during the crisis period was affected by the cars component, which benefited from subsidies in the form of vehicle scrappage schemes that were larger than in the other euro area countries and proved to be rather effective.^[8] Moreover, the household sector in Germany was more resilient than in other large euro area countries.

Given their volatility and pro-cyclicality, durable goods expenditure historically accounts for a relatively large share of the variance in GDP despite its modest size, in particular relative to non-durable goods consumption. Table 1 shows the share of consumption and its components in terms of GDP, and the corresponding share of GDP variance explained. Total private consumption accounts for two-thirds of GDP in the United States and slightly more than one-half in the euro area. However, its overall contribution to the variance of GDP is typically smaller given the smooth behaviour of services, the largest component within non-durable consumption items. By contrast, in France, Italy and Spain, as well as in the United States, durables contribute to a larger share of the variance in GDP growth relative to their size. From that perspective, expenditure on durables bears some resemblance to the characteristics of investment, which, despite its smaller size in aggregate demand, accounts for a disproportionately large share of output fluctuations.

2.2 Turning point analysis

Turning point analyses focus on identifying time periods in which an economy switches from one regime to another, for instance from a phase of expansion to a phase of contraction, and vice versa. In this section, results for the euro area are shown based on two different approaches for defining a recession. One approach is based on the official business cycle dating methodology used by the Euro Area Business Cycle Dating Committee of the Centre for Economic Policy Research (CEPR).^[9] The other is a modified version for quarterly data by Harding and Pagan (2002) of the original Bry and Boschan (1971) dating algorithm (hereafter MBBQ algorithm).^[10] This algorithm is a multi-step, automated method to identify turning points on the basis of assumptions about the relative size of peaks and troughs and the minimum duration of the different phases of the business cycle.

Recessions in the euro area, based on CEPR official dating, tend to coincide with downturns in both GDP and most expenditure components, including durable goods consumption. Chart 3 shows CEPR recessions in the euro area (grey vertical bars delineated by black borders) alongside downturns in GDP and expenditure components identified on the basis of the MBBQ algorithm (coloured bars). The fact that recession periods tend to coincide with clusters of identified downturns for most GDP expenditure components is in line with the notion that a recession is a generalised phenomenon spread across the whole economy. At the same time, the decline in durable goods expenditure around downturns in the broader economy signals that purchases of durables are highly synchronised with developments in activity and thus carry important information about the phase of the business cycle.

Aside from downturns coinciding with official recessions, turning points in durables have also occurred historically outside recessions but during periods typically characterised by economic weakness. One such occurrence, for instance, was in the early 2000s, when economic activity in the euro area experienced a significant loss of momentum.^[11] In tracking such episodes of “soft patches” in the economy, durable goods expenditure bears some resemblance to the behaviour of investment – another component of demand that tends to be both highly volatile and strongly pro-cyclical.^[12] At the same time, the existence of “false” recessionary signals coming from the most volatile components of GDP cautions against over-relying on any single indicator, since it may embody sector-specific, rather than economy-wide, weakness.

Another interesting observation is that the identified downturns in durable consumption have tended to anticipate the official start of the two recessions in the euro area dated by the CEPR. While the limited recession episodes in the euro area invite caution against drawing strong conclusions, this leading feature in durable goods expenditure is also evident in the longer sample for the United States, which stretches over six decades, thereby capturing a larger number of recessions (see Chart 4). As with the euro area, the evidence from the United States also seems to suggest that the signal provided by durables regarding the change of phase in the business cycle tends to be less noisy than the one based on investment components. At the same time, it appears more consistent in signalling shifts between economic regimes than other consumption items such as services, which often do not exhibit turning points during official recessions.

3 Durable consumption, credit and financing conditions

Credit availability is important for households’ ability to smooth consumption over the business cycle. Financing conditions are particularly relevant for the purchase of big-ticket items such as durables, which, because of their longer lifespan and higher unit value, are more often acquired with credit and are sometimes eligible for use as collateral to secure the underlying credit claim.^[13] Box 2 provides further details on the use of credit for durable goods purchases in the euro area.

As a result, durables correlate closely with demand for consumer credit and can provide important insights into the state of financing conditions in the economy. As shown in Chart 5, phases of sustained growth in durable goods consumption, such as during the period of expansion prior to the global financial crisis or the more recent one in 2013-19, tend to coincide with increases in demand for consumer loans typically used by households to finance purchases of durables. Likewise, the close co-movement between durables and demand for credit was present during the double-dip recessions in the euro area. Moreover, during the global financial crisis in 2008-09, the tightening of credit standards by banks restricted the availability of credit from the supply side and coincided with a significant contraction in durable goods purchases.

Divergent patterns in durable goods expenditure across different countries can therefore also reflect heterogeneity in financing conditions. Chart 6 displays durable goods consumption, expenditure on cars and consumer credit during two phases of the business cycle, for the euro area as a whole and across the four largest economies. The first period, 2008-12, was dominated by the double-dip recession and was followed by a phase of sustained recovery. While durable goods expenditure stagnated and credit contracted in the euro area as a whole during the first period, these developments – in the form of a sharp contraction – were particularly evident in Italy and Spain, countries heavily affected by the euro area financial and sovereign debt crises. By contrast, in the second period starting in 2013, as credit availability improved and the crisis-induced dispersion of financing conditions across euro area economies declined with the support of policy measures, both credit growth and durable goods expenditure – including purchases of vehicles – recovered, expanding at above-average rates in Italy and Spain. In particular, the recovery in credit in the latter phase was driven by the strong take-up in new medium and long-term consumer loans, the type of loans predominantly used by households to finance purchases of big-ticket items.^[17]

In particular, car purchases stand out as a major item within durable goods consumption – at around 40% of the euro area total – that is strongly affected by financing conditions (see Chart 7). What usually makes a vehicle suitable for financing, in addition to being more easily used as collateral, is its high unit value in proportion to income, its relatively long lifespan and its relatively low rate of depreciation.^[18] Given the high cost involved in upgrading and adjusting the stock of major items such as cars, households’ intentions to make major purchases are strongly correlated with income expectations and their financial situation. As a consequence, the pattern of car purchases mirrors aggregate financing conditions and the strength of the economic cycle.

Expenditure on cars can also be an idiosyncratic source of fluctuations in durable consumption. This is due to the systemic relevance of the car industry for the overall economy – sometimes leading to the implementation of countercyclical policy support (e.g. subsidised vehicle scrappage schemes) – and to regulatory changes and technological advances. For instance, the rebound in car purchases in 2009, in the middle of the financial crisis, was bolstered by the wide-spread implementation of subsidies for vehicle scrappage schemes across the euro area, ranging from €1,000 per car in France to €2,500 per car in Germany.^[19] The car-led recovery in durables during the recession proved to be short-lived, as the subsidies mostly brought forward future demand.

In the course of the latest expansion, expenditure on cars has provided a major impetus to the sustained growth in durables amid supportive financing conditions and the easing of banks’ credit standards for consumer loans since 2014. During this period, favourable funding conditions are likely to have supported durable goods expenditure more effectively since durables tend to react more strongly to monetary shocks during expansions than during recessions, as consistently found in the literature.^[20] Using micro data, Box 3 investigates the heterogeneity across households in car purchases and the use of car loans during the recovery. In the past two years (2018-19), expenditure on cars experienced a slowdown amid substantial volatility, in part related to changes in environmental regulations and uncertain prospects about both the future use of diesel combustion engines and the speed of diffusion of electric cars.

4 Relative prices and relative consumption of durables

Over the long run the relative price of durables exhibits a sustained downward trend. The relative price, as measured by the ratio between the consumption deflators of durables and non-durables (the latter including semi-durables and services), has declined by almost 40% in the euro area since 1999 (see Chart 8). The increase in the affordability of durables has benefited from globalisation trends and has been observed also in other advanced economies, such as the United States, the United Kingdom and Japan. Since the mid-1990s, globalisation has increasingly allowed firms to source low-cost imports of consumer goods from new locations in emerging markets and to move production capacities to such destinations.^[24] In addition, rapid technological advances have lead to a constant decline in prices for durable goods items such as electronics, while posing challenges to quality adjustments in the statistical measurement of price changes. Box 4 sheds light on the importance of durable goods for HICP inflation in the euro area.

Over time, the decline in relative prices has coincided with a rise in real durable consumption relative to other items. As evident in Chart 8, favourable price developments have contributed to an increase in the share of durables in total consumption in real terms, despite a modest decline in the corresponding nominal share. Moreover, panel (a) in Chart 9 shows the common nature of this phenomenon being observed over the long run, not only for the euro area as a whole but also across its four largest economies. At business cycle frequency, however, relative durable consumption can respond to country-specific economic conditions, being affected by pent-up demand and catch-up effects. Panel (b) highlights that, even though relative prices continue to decline during weak phases of the business cycle, sometimes consumers fail to take advantage of favourable price conditions. For instance, in Italy and Spain during the period 2008-12, other factors such as declining disposable income and increasing unemployment hindered consumption more broadly. The postponement of purchases of big-ticket items in the middle of the protracted recessionary phase led to an ageing stock of durables generating pent-up demand.^[29] As a consequence, the subsequent expansion, as displayed in panel (c), may well have been associated with catch-up effects as economic conditions improved.

5 A structural decomposition of consumption taking into account durable goods-specific shocks

The aim of this section is to empirically assess the drivers of total consumption, allowing for durable goods-specific factors to play a role. In the empirical literature few studies distinguish durables consumption from non-durables consumption and explore how they are interconnected, especially for the euro area. The limited existing analysis in this area is because aggregate data on euro area durables expenditure have not yet been published officially and have only recently become available for all individual countries. Moreover, the specific characteristics of durables discussed previously – namely durability, depreciation and sensitivity to credit conditions – make it more challenging to incorporate them into a consumption model alongside non-durable expenditure items.

The empirical analysis is based on a vector autoregressive (VAR) model featuring durable goods, where the structural shocks are identified based on theory.^[30] The underlying idea is that overall consumption is better modelled by treating expenditure on durables and non-durables separately, given their asynchronous adjustment, as well as the possibility of spillovers from durable-specific shocks to non-durable consumption in the presence of liquidity constraints.^[31] The model uses five variables, volumes and prices of durable and non-durable consumption and the nominal interest rate on consumer credit. To interpret the evolution of consumption in terms of fundamental drivers, five structural drivers are identified: durable goods-specific demand and supply, aggregate (approximated by non-durables) demand and supply, and broad monetary conditions capturing both monetary policy and the credit environment. The identification relies on a mix of zero and sign restrictions as informed by a theoretical model. The VAR model has time-varying parameters and is estimated with Bayesian techniques.

The methodology allows consumption to be decomposed into contributions from structural shocks. Chart 10 presents a historical decomposition of overall consumption and of durable goods consumption growth in the euro area. Focusing on overall consumption, the results in panel (a) suggest that, against the background of prevailing negative aggregate supply shocks between 2008 and 2013, the main cyclical drivers of consumption in both the financial crisis and the sovereign debt crisis were demand-side factors, as their contribution triggered both downturns throughout the episodes of the crises, as well as the brief recovery phase in between. The negative effects from demand factors were compounded by unfavourable monetary conditions during the financial crisis.^[32] The model assigns a strong positive role in the initial years of the recovery, which started in 2014, to aggregate supply-side shocks. These shocks captured, together with other factors, a positive impact from very low energy prices, as they coincided with an unexpected drop in oil prices that gave a considerable boost to euro area households’ purchasing power and thereby supported consumption expenditure.^[33] The slowdown in consumption growth since 2018 can be explained by a combination of demand and supply shocks, the latter possibly capturing the adverse effects on consumer purchasing power from rising energy prices since 2017.

The results from the model confirm the pro-cyclical role played by durable goods-specific factors. In particular, durable goods-specific supply shocks have continued to provide positive, albeit modest, support to consumption throughout the last years of the sample ending in 2019. By contrast, the negative contribution from durable goods-specific demand factors since approximately 2016 may capture the waning of catch-up effects arising from the accumulation of pent-up demand for durables during the crisis.

Aggregate macroeconomic shocks contribute strongly in driving durable consumption and the broader economy. As expected, durable goods-specific shocks play a larger role in driving durables expenditure (see panel (b) of Chart 10) than overall consumption (see panel (a) of Chart 10). At the same time, aggregate shocks –such as shocks to aggregate demand, aggregate supply and monetary conditions – matter at least as much for durables as sector-specific shocks. This validates the evidence that durables are greatly affected by the broader business cycle and thus they are a useful indicator for tracking cyclical conditions in the economy.

6 Conclusions

Focusing on longer-run trends, this article has explored the role played by durable goods as a cyclical driver of euro area consumption. On the basis of the empirical results, the slowdown during 2018-19, in comparison with the buoyant dynamics in consumption during the earlier phases of the latest recovery, is best interpreted as a normalisation following the dissipation of some favourable but transitory factors at play in the preceding years.

Looking ahead, with the spread of the coronavirus having triggered a deep recession, expenditure on durables is very likely to contract severely in 2020 owing to many shops closing under lockdown and households postponing purchases of big-ticket items. In the current environment of high uncertainty, past experience highlights the benefits for economic analyses coming from the availability of durable goods expenditure data and invites policymakers to monitor closely the behaviour of durables, as they can help track the health of the broader economy and provide clues about the path to recovery. If the pandemic crisis turns out to be temporary and financial amplification effects can be contained, as expected, the delay in durable purchases in the short term may generate pent-up demand and bring catch-up effects later on, once economic conditions normalise. In a less favourable scenario, the rebound in durable consumption may be more muted as households readjust to a lower desired stock in view of lower long-run income expectations.