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