Thursday, March 22, 2018

The Consumption Conundrum

Ireland’s national accounts get a bad rap but amidst all the distortions one would think that personal consumption expenditure on goods and services (the “C” of C + I + G + (X – M)) would be a distortion-free zone.  Of course, in relative terms, the consumption component of aggregate demand is as oasis of calm but there are a few wrinkles worth exploring.

By almost all metrics the Irish economy is motoring along nicely.  Employment is growing rapidly (+3.1% in Q4 2017), full-time employment is growing even faster (+5.4%) average weekly employees earnings are rising (+2.5% in Q4), agricultural incomes boomed (+35.2% in 2017) and though we have seen some modest income tax changes the PAYE and total USC component of Income Tax was up 8.6% in 2017.  And the population is growing (+1.1% in the year to April 2017).

But is this being translated into consumption growth?  Here are the year-on-year growth rates of personal consumption expenditure from the Quarterly National Accounts with the Q4 2017 update provided last week.

QNA Consumption Year on Year Real Growth 2011-2017

The improvement from 2011 to the middle of 2016 is probably close to what one would expect.  Growth rates returned to positive territory and then continued to edge upwards.  But the growth rate slumps from the middle of 2016 and has hovered around two per cent for the past 18 months or so.  Such sluggish growth does seem to fit with the strength seen across other indicators (a point made recently here).

We do have indicators that point to more rapid growth in consumption. At the end of 2017 the Retail Sales Index was showing volume growth of more than six per cent (excluding the volatile motor trades).

Retail Sales Index Dec 17 Growth

The index does show a slowdown in growth (but from mid-2015) rather then (mid-2016) but only briefly fell to three per cent and has been moving upwards for the past 18 months or so.

So why isn’t this being reflected in the growth of consumption in the national accounts?  One reason why the rates are different is because the measures are different.  Retail sales are only one element of consumption and exclude almost all services consumption.

The largest item in consumption is housing services.  Housing accommodation makes up one-fifth of the national accounts measure of consumption for Ireland (in nominal terms it was €17 billion out of €87 billion in 2017). 

For tenants, the amount of money paid on rent represents their spending on housing (or at least on the accommodation part).  But about 70 per cent of Irish households don’t make a regular payment for their housing – they are owner-occupiers.  They may make mortgage payments but that is a combination of a loan repayment (saving) and an interest payment for a different service – credit. For these households an “imputed” rent is calculated as if the owner was renting from themselves. 

This “imputed rent” is also counted as household income but as it is matched by imputed expenditure the net effect is zero.   Of the €17 billion of rent in consumption in 2017, €4 billion was actual rent paid by tenants and €13 billion was the imputed rent of owner-occupiers.

Regardless of the ins and outs and it should be little surprise to see that our consumption of housing has been pretty static recently. 

Housing Consumption 2004-2016

It is hard for the consumption of housing to increase when the stock of housing available for consumption is barely increasing.  So, even if other the other components of consumption are growing strongly (as the retail sales index suggests) the overall growth rate of consumption will be dragged down because the largest component (housing) is not growing at all.

But that doesn’t explain the fall off in growth seen in 2016.  We don’t get a quarterly breakdown of the components of consumption so we can only look at annual data.  In annual terms the real growth of real consumption has gone from 4.4 per cent in 2015 to 3.3 per cent in 2016 to 1.9 per cent in 2017.  Housing may be dragging the overall rates down but it is not causing them to fall.

One culprit might be insurance.

Insurance Consumption 2004-2016

Whoa!  This shows a 80 per cent fall from 2005 to 2012 and then a 200 per cent rebound up to 2014 and declines since.  Insurance isn’t a huge component of consumption (the nominal amounts are fairly close to the constant (2010) price amounts shown in the chart) but it has been volatile in recent years.

The volatility may be down to how insurance is included in consumption.  There are a number of moving parts but in rough terms it is net cost to households, i.e. Premium + Supplements – Claims.  Part of the reason for the rapid increase since 2012 shown above was a fall in claims.  They were €9.7 billion in 20112 and had fallen to €8.7 billion by 2015.

So the consumption of insurance rose rapidly from 2012 but not necessarily because households were spending more on insurance premiums but because they were getting less back in claims.  And this may have reversed in recent years so higher claims reducing the consumption of insurance. 

As stated insurance is a relatively small component of consumption but it may be partially to blame when it comes to the growth of consumption not matching our expectations based on other indicators.  And the detailed data only yet go up to the 2016.  We will learn more when we see the 2017 figures later in the year. 

The growth rates of consumption for items such as food, clothing and furniture did slow markedly in 2016 compared to what they were in 2015 but we’ll wait until the updated (and possibly revised) figures up to 2017 are published before establishing whether this is a pattern.  There is something funny going on with the volume figures for hospital services in personal consumption expenditure but it probably doesn’t add much to our narrative here though it may be a reason for some revisions.

The growth of consumption is lower than we might expect but, in looking at housing and insurance at least, this seems likely to be due to how consumption is measured for national accounts purposes rather than anything untoward in household spending patterns.  The retail sales index is probably better aligned with the money coming out of people’s pockets and the growth of that continues to tick up. 

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