Power resources - Prices ; Dollar, American ; Consumption (Economics)

Brian Motley

English

Research Papers in Economics

FRBSF WEEKLY LETTER
June 12, 1987
Consumption, Oil Prices, and the Dollar
Last year, households increased their consump-
tion expenditures by significantly more than the
rise in their incomes. Over the four quarters of
the year, personal consumption expenditures,
adjusted for inflation, rose four percent, while
personal disposable income increased less than
two and one-quarter percent. As a result, saving
by households declined to only 3.8 percent of
their disposable income - the lowest annual
saving rate since 1947.
The share of national income that the private
sector has chosen to save has been trending
downward for a number of years. But the
decline last year was particularly sharp. A
reduced supply of domestic savings means
either that less funds are available to finance
capital investment and the government's deficit,
or that the inflow of foreign savings into the
United States must increase.
In 1986, the shortfall in domestic saving was
made up by a huge inflow of capital from
abroad. This inflow, which was the financial
counterpart of the nation's international trade
deficit, provided almost a third of the $432 bil-
lion needed to finance net investment in physi-
cal capital and the federal deficit. If the share of
the national income saved by the private sector
had been as high last year as it was in the 1970s,
our demand for foreign savings could have been
cut in half and, as a result, real interest rates in
the u.s. would have been substantially lower.
There are reasons to believe that last year's burst
of consumption spending was the result of spe-
cial events that are unlikely to be repeated. As
households adjust their personal saving toward
more normal levels relative to their incomes,
household demand for goods and services will
be weaker. Although this is likely to hurt the
parts of the economy that supply consumer
goods, and make the continuation of the eco-
nomic expansion dependent on growth in other
sectors of the economy, some slowing in the
growth of household consumption is desirable.
From a longer run perspective, a higher level of
domestic savings will help us to reduce our
trade deficit and keep interest rates down.
Saving, oil, and the dollar
One important temporary factor boosting house-
hold spending last year was the abrupt fall in the
price ofoil- between January and April, the
price of crude petroleum was cut in half. The
resulting reduction in the cost of their purchases
of gasoline, home heating oil, and other
petroleum products meant that households had
more real income available to spend on other
items. It is true, of course, that the oil price
decline also led to painful losses of jobs and
income for those involved in the production of
oil as producers reduced their output and sold
that output at lower prices.
Nonetheless, the overall effect of the oil price
drop on real incomes appears to have been posi-
tive. Since the u.s. used more oil than it pro-
duced domestically, the beneficial effects of the
price decline on the users of oil offset the delete-
rious effects on the producers, even though the
latter commanded more attention because pro-
ducers are concentrated in particular regions of
the country.
A second factor that may have had an effect -
in this case negative - on household consump-
tion last year was the decline in the international
value of the dollar. A lower value of the dollar in
terms of foreign currencies means that the prices
of imported products rise. As a result, the pur-
chasing power of households' incomes is
reduced, and household consumption tends to
decrease.FRBSF
The effects of the oil price decline and of the
dollar depreciation, although working in
opposite directions, are analogous. Because a
decline in the price of imported oil means that
we can obtain oil from abroad in exchange for a
smaller volume of exports, more of our total out-
put is available for domestic use. Last year, for
example, the dollar value of our oil imports
declined by a third but thequantity imported
increased by one fourth. Conversely, the dollar's
depreciation caused the prices of our non-oil
imports to rise relative to those of our exports.
We had to export more goods and services in
order to purchase a given volume of non-oil
imports, leaving less output available for domes-
tic use. On balance, the beneficial effect of the
oil price decline outweighed that of the dollar's
depreciation.
Measuring the effect
I have attempted to estimate the quantitative sig-
nificance of these two factors on household con-
sumption using a statistical model of the U.5.
economy developed at this Bank. In this model,
households' expenditures depend primarily on
their income. The share of the nation's output
that goes to households is determined by the
government's system of taxes and transfer pay-
ments, but the purchasing power, or real value,
of that income depends on the prices of con-
sumer goods. An increase or decrease in the cost
of imports affects the average prices that house-
holds face and therefore changes their real
incomes and leads them to alter their consump-
tion spending. In particular, lower imported oil
prices tend to stimulate consumer spending,
whereas a depreciation ofthe dollar, by raising
import prices, tends to have a negative effect.
This model was used to estimate the importance
of the oil price decline and the dollar deprecia-
tion on the behavior of consumer spending since
1984. The estimates were made by simulating
the consumption sector of the model, holding
constant the price of oil and the real exchange
rate, respectively, and comparing the simulated
path of consumption with that which actually
occurred.
The simulations assume that real GNP followed
the same path as it did historically. Thus, they
do not take account of the fact that a different
pattern of household spending would have
altered the level of incomes earned in the indus-
tries producing consumer goods and thereby
caused "multiplier" effects elsewhere in the
economy. They also ignore the probability that
the depreciation of the dollar and the oil price
reduction led consumers to substitute between
domestic and foreign products. Nevertheless, by
suppressing all their other effects on GNP, this
procedure has the advantage of highlighting the
direct effects of the dollar and oil price deprecia-
tion on consumption.
The accompanying chart shows the results of
these simulation experiments. The effects on
household spending of last year's decline in the
price of oil appear to have been substantial. The
simulations indicate that if oil prices had not
declined, real consumption expenditures on
nondurables and services in 1986 would have
been lower by about $13 billion. The growth in
these expenditures over the four quarters of the
year would have been reduced from its actual
pace of almost 3 percent to around 21/4 percent.
However, the model suggests that the effects of
the depreciation of the dollar in reducing con-
sumer spending were much smaller. The decline
in the exchange rate after February 1985
appears to have lowered real outlays on nondur-
ables and services by only about $1 billion. The
effect on the growth rate of consumption was
negligible. Moreover, since the dollar's decline
probably led consumers to substitute U.S.-pro-
duced goods for imports, it is likely that, even
though the depreciation caused consumption
spending as a whole to decline slightly, its net
effect on domestic producers of consumer goods
was positive.
1987
The positive effects of last year's oiI price
decline are now largely over. Indeed, oil prices
have been rising in recent months. The depress-
ing effects of the decline in the dollar's value onGrowth of Consumption of
Nondurables and Services
1885
Percent
6
5
4
3
2
. Constant
Exchange
\
1884
Actual Growth
Rate """
1886
household spending seem likely to continue,
both because the dollar has continued to
depreciate in 1987 and because its effects are
passed through to import prices with a fairly
long lag. Hence, the household spending com-
ponent of the aggregate demand for goods ant!
services is likely to be less robust this year than
it was in 1986. In the first quarter of 1987, the
personal saving rate increased to 3.4 percent
from its record low of 2.7 percent in the second
half of last year. Although this rate remains low
compared to its historical average of around 7
percent, it is evidence that households already
have begun to bring their consumption into a
more normal relation with their real incomes.
Brian Motley
Opinionsexpressed in this newsletterdo not necessarily reflect the views ofthe managementofthe Federal Reserve Bank of San
Francisco,orofthe BoardofGovernorsofthe Federal Reserve System.
Editorial commentsmaybeaddressedtotheeditor(GregoryTong) ortotheauthor....FreecopiesofFe<leral Reserve publications
can beobtained from the Public Information Department, Federal Reserve Bank ofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6u!450m 40~n U060JO 0POI\0U
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
5/20/87
Change
from
5/13/87
Change from 5/21/86
Dollar
Loans, Leases and Investments1 2 206,450 2,470 2,382 1.1
Loans and Leases1 6 183,747 2,389 - 1,226 - 0.6
Commercial and Industrial 53,762 621 697 1.3
Real estate 68,375 321 1,538 2.3
Loans to Individuals 37,270 - 19 - 3,375 - 8.3
Leases 5,373 - 9 - 260 - 4.6
U.S. Treasury and Agency Securities2 15,394 77 4,158 37.0
Other Securities2 7,309 4 - 552 - 7.0
Total Deposits 205,625 1,219 3,802 1.8
Demand Deposits 52,590 735 4,159 8.5
Demand Deposits Adjusted3 48,063 - 47 3,427 7.6
OtherTransaction Balances4 19,220 49 3,506 22.3
Total Non-Transaction Balances6 133,815 435 - 3,863 - 2.8
MoneyMarket Deposit
Accounts-Total 44,720 117 - 1,720 - 3.7
Time Deposits in Amounts of
$100,000 or more 31,745 135 - 5,197 - 14.0
Other Liabilities for Borrowed MoneyS 23,693 718 - 1,701 - 6.6
Two WeekAverages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Net borrowed(-)
Period ended
5/18/87
81
43
38
Period ended
5/4/87
19
104
84
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading accountsecurities
3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowing via,.FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change

Consumption, oil prices and the dollar

http://www.frbsf.org/publications/economics/letter/1987/el87-24.pdf

Consumption, oil prices and the dollar

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