The Role of Consumption in Economic Fluctuations

Abstract

Consumption is the dominant component of GNP. A 1 % change in consumption is five times the size of a 1 % change in investment. This paper investigates whether the behavior ofconsumers is an independent source of macroeconomic fluctuations or whether most disturbances come from other sectors. Informal commentaries on the business cycle put considerable weight on the independent behavior of consumption. It is commonplace to hear of a business revival sparked by consumers. On the other hand, all modern theories of fluctuations make the consumer a reactor to economic events, not a cause of them. Random shocks in technology are generally the driving force in fully articulated models. This paper develops a framework where the distinction between a movement along a consumption schedule and a shift of the schedule is well defined. Application of the framework to twentieth-century American data shows that shifts of the consumption schedule have probably been an important cause of fluctuations but have probably not been the dominant source of them. I consider three sources of disturbances to the economy: (1) shifts of the consumption schedule; (2) shifts of the schedule relating spending in categories other than consumption and military spending; and (3) shifts in military spending. The reason for the explicit examination of military spending is that such spending is the only plainly exogenous Robert E. Hall is professor of economics at Stanford University. I am grateful to Olivier Blanchard and Ben Bernanke for comments and to Valerie