Household Consumption: Why is it still below the pre-pandemic peak?

Stagnant private consumption is behind the slow economic recovery

The Annual Report on the National Accounts for FY2021 was released by the Cabinet Office on 8 December 2022. According to the revised seasonally adjusted GDP figures, real GDP recovered the pre-COVID-19 pandemic peak reached in the first quarter of 2020 (henceforth, 2020 I) only in 2022 II. The pace of recovery is considerably slower than that in China, the United States, and the Euro-zone economies.

According to Figure 1, which shows the breakdown of the difference in real GDP between the pre-COVID-19 pandemic peak and the most recent quarter (2022 III), the recovery is due to the positive contribution by “government consumption” and “change in private inventories” (Figure 1). Other components, including “private consumption”, is still below the level reached in 2020 I.

Household consumption still hasn’t recovered the pre-pandemic peak

Private consumption is the largest component of GDP and has more than 50 percent share. If it had increased even by a modest amount, it should have a large impact on the GDP and the recovery would have been quicker. However, as Figure 2 shows, the recovery from the large drop in 2020Q1 has been unsteady and remains below the level in 2020 I, and significantly lower than the level achieved before the consumption tax rate-hike in 2018 and the first three quarters of 2019.

Private consumption comprises of consumption by private non-profit making organizations, direct purchase abroad by resident households, direct purchase in the domestic market by non-resident households (subtraction item), and domestic final consumption expenditure by households (henceforth, household consumption). Figure 3 shows that the slow recovery of the private consumption is mainly due to weakness of the domestic household consumption.

Household financial assets have been accumulated instead of being spent

The reason for the weakness of household consumption is somewhat puzzling because households have been accumulating financial assets since the latter half of 2020. It owes to the increase in cash and deposits that reflect the special cash transfer made by the government to all individuals in the early days of the COVID-19 pandemic. As Figure 4 shows, the increase in cash and deposits has been partly offset by the decline in share and investment trust during 2020, but as its negative impact gradually faded-out, total assets started to rise.

The build-up of financial assets could be a result of the households’ response to the increase in prices in order to preserve the real value of the financial assets. It may be able to explain the build-up taking place since the beginning of 2022, but not those in the earlier periods.

Stagnant spending on services is prominent

In order to identify the reason for the slow recovery in household consumption, it is broken-down into consumption of goods and that of services. As Figure 5 shows, while consumption of goods has been relatively stable, consumption of services has been stagnant after the steep drop in 2020 II: as a result, the ratio of consumption of goods to that of services has risen and has stayed at an elevated level until the most recent quarter. The slow recovery of household consumption, therefore, can be attributed to the stagnant consumption of services.

Probably not because of the changes in prices nor the liquidity constraint

Weak household consumption can come from both supply-side and demand-side factors.

Supply-factors that would prevent household consumption to take place would include shutdown of business, as we witnessed in the early days of the pandemic as a result of the declaration of state of emergency. However, since such a restriction has not been imposed by the government during the last two quarters, we can exclude such a supply-side factor.

As for the demand-side factors, there are three possibilities that could result in the slow recovery of services consumption: first is the rise in prices, second is the liquidity constraint, and the third is the change in household’ preference.

Firstly, one may think of a rise in prices as a factor in discouraging consumption because of the inflationary environment we are currently in.

However, as Figure 6 shows, prices of services have fallen since Spring of 2021 and have stayed low since then. Therefore, rise in prices should not have discouraged consumption of services by households.

Secondly, liquidity constraint faced by households is a possibility. Faced with the rise in prices of goods, which include food and energy, low-income households may have had to reduce the consumption of services, which consist mainly of non-necessities, in order to finance the consumption of the necessities.

However, as the building-up of households’ financial assets shows, at least in the macroeconomic-sense, we probably can exclude this case as well.

Probably because of the change in households’ behavior

Thirdly, there may have been a change in households’ preference. To see whether that is really the reason, the categories of services that are subject to low consumption by households needs to be identified.

Due to the availability of the data, Figure 7 shows the breakdown of nominal household consumption of services by households with more than two members by categories in annual terms taking the level at 2018 as 100. According to the figure, the categories of services that are still below 2019 levels at 2022 are “cleaning”, “eating out and school lunch”, “cultural and entertaining activities”, and “transportation and communications”.

Cost of people’s choice to counter COVID-19

Figure 7 suggests that the categories of services that haven’t recovered the 2019 levels are those which would be affected if households refrain from going out to eat or to travel to enjoy themselves. Since there are no official restriction imposed on people’s activities at the moment, such as the declaration of state of emergency, the low spending on these activities should be reflecting the self-restraint by the households in engaging in those kinds of activities. It should be regarded as a result of the choice made by the households in order to cope with the risks of infection of COVID-19.

There are three ways to overcome COVID-19; (a) everyone has been infected (gained herd immunity), (b) effective vaccines and remedies have been developed, and (c) people are taking precautionary measure to avoid being infected. Since the first two ways are either too costly or still risky, people seem to be taking the third way. However, contrary to the first two, the third way is the one which would significantly affect the economy, especially the services industry. This situation seems to be the one that has been chosen in Japan.