Analysis of Household's Consumption and Savings Behavior

It is hard to imagine describing the economy without the involvement of consumers, especially the household consumer. There has been so much economic growth and development over the past few years, of which most are attributed to household consumptions. We all need certain goods and services in our homes, which come from firms. It is these firms that makeup markets, which means the markets – and consequently, economies will fail if there are companies within them. A good example was the condition that followed the 2008/2009 great recession. During this time, markets collapsed directly from the economic bubble that preceded this condition. And the most hit industry was one that involved household consumption. Which, unsurprisingly, has an extensive impact on the rest of the world economy. More stable economies were better off since they already had in place policies that shielded their citizens against the hot flames of an economic crisis. Developing and less developed economies, on the other hand, were hardest hit; they had to struggle with adjusting and making up new monetary and fiscal policies as household members continue to wait on them.

Household saving and consumption action play a vital role in both short-term and long-term economic growth and development. It is one of the major determinants for GNP and GDP in most countries. Economists use household saving rates to understand the ability of a firm, and states take credits for investments. For instance, if there is a company producing shoes, they can get a loan based on how much sales they make, if they want to grow their business. Note that even though economies seem to have similar characteristics on many grounds, the household saving rate is never the same in the different nations when you consider a higher income level. Some countries have lower rates, while others have higher rates, with those with low savings potentially facing a problem in finding enough credit to finance investment. In other words, these countries will need to look for credit to finance their investments from different places with a higher rate of the household saving net. It is very hard for financiers to support investments in countries with low or negative credit because it puts them vulnerable to external threats. When conditions like economic crises and downturns happen, these financiers face the highest risks of losing their investments. Economic data indicate that the household saving rate varies across countries and times, starting from the rate below zero and going all the way above twenty. We can always take a guess about these factors based on the countries' living standards and economic stability.

Household consumption

No one can deny the rapid economic development and urbanization being witnessed in many countries across the globe. They are all part of economic growth for the nations, in which household consumption plays a key role. In the developing countries, for instance, economic growth is mainly fueled by household consumption – it is a force that contributes largely towards dampening private consumption, creating an effect across aggregate demand and economic activities. Many of these nations, the household consumption expenditure, account for more than 50% of the GDP. It is all about the consumption of domestic goods by the locals. This means that when citizens consume more of the goods produced within the country than they do imported goods, they contribute largely to the economic growth of their country in the long-term and short-term. Hence, the growth of GDP and household spending seem to have a force that pulls them together.

One of the main reasons for this is the creation of different policies aimed at boosting household expenditure. The government must always realize the importance of this economic aspect and strive to make sure nothing makes it any less important as it should be. They need to consider it seriously to make change economic orientations within their countries. Some do this by identifying areas, such as farming, business development loans in rural areas, and other things, to ensure consumers are getting enough goods and services. An economy is seen to be good if household consumption and saving on the pick.

Consider the cased of Thailand, for instance, in recent years has launched several stimulus measures with a great focus on the rural population. It is the same thing happening in more developing economies, with governments shifting their focus more on small and medium-sized enterprises. The including on women in economic matters as well as their empowerment has been of great support to these economies, too, with everything being linked to household consumption. Measures such as low-interest loans with better-paying terms, credit guarantees, tax exemptions, tax cuts, and venture capital funds have been fundamental in helping these consumers.

The main reason for the measures mentioned above is mainly to build short-term consumption by pushing up household debt, which is fundamental to economic growth. As if that is not enough, household debt can help people create smooth consumption behavior over their lifetimes and build physical assets like land and houses. We can, therefore, safely say that household debts quantitively affect consumption.

Governments and other stakeholder need to the process that creates effective household consumption. In recent years, the world of economics has seen many studies that investigate the effects of household debt based on household expending. All these studies are key to understand why consumers behave in specific manners, which then leads to making investment decisions that bear fruits. When firms are making investment decisions, they look at the consumption rates of the goods they want to put out on the market or improve before creating a roadmap to them. Studying these patterns is a great way to know what can work or what will not work within a market setting. Household saving is just as important as consumption. When people save, it means there is enough for investors to use into different investments. As stated above, countries with very low consumption and savings do not have the best odds for economic growth.

In other words, studying these patterns lets firms and governments make decisions that affect not only the consumers but the economies at large. Some empirical studies suggest that the ratio of debt associated with land and housing purchases to the market value of solid properties negatively affected expenditure following the bubble burst. In addition, some discovered that the debt-asset rate had a similar effect on expenditures when considering semidurable and nondurable goods. Generally, we can say that an indebted household is one that has specific asses, with more household income, better education level, and large household expenditure, among many other factors. A household that does not have a debt on the hand has few effects, no household income, they spend less and much more. An indebted household is, therefore, higher than a debt-free one.

Economic decisions are made based on data. And this data comes from a clear study of relevant factors and processes. It is for this reason that studying consumer expenditure and consumption has become a vital aspect of modern economies. This data is vital to the government when taking statistics about its citizens in order to help them through various economic situations.

It has been argued that household consumption should be studied separately from household debt decisions. This is because the main difference between indebted and debt-free households comes from themselves choosing to get into loans to satisfy their consumption needs.

The Copula-based model

This is a drawback that has been addressed through a copula-based endogenous switching model, which is applied in the investigation of household debt based on consumption expenditure and the measurement of household debt effects. This is one of the most applied modules because it allows for more flexibility in joint distribution compared to bivariate normal distribution. In addition, a large number of copula functions are applied in offering a more general dependence structure, as opposed to looking at it as a simple correlation, in other words. The copula-based model can fit the data where needed better than normal endogenous methods. The copula is defined as a better approach when relating to bivariate or multivariate distributions in the econometric model.

Household saving

In order, if to understand these subjects, one must first know how to interpret them and explain what saving is all about. There are different approaches to defining household saving. These definitions are used as a significant part of determining to bother how trends change in household saving, and why they decide to save. Poterba (2002) offers two approaches to a household saving definition. In the first approach, he looks at it as the difference between income and flow of expenditure during a certain period. In the second definition, he says it is the differences in household net wealth and income over a specified period of time that equates to the definition above added to any capital gain or losses on current assets with the period. Sometimes these gains and losses in the capital can stand for more than just the flow of savings less expenditure during a given period. More studies of household saving do not rely on these definitions very much because there is no telling exactly how much gain or loss has been achieved. Hence, most researchers only depend on the first explanation.

Other definitions consider the change in net equity in the pension fund reserves within the net household savings. In this case, it is stated that the net household saving is the same as the disposable income not spent on the final no consumption addition to the difference in the equity of households in terms of pension funds.

Theories used in household saving

The life-cycle approach

In this case, we shall be looking at the life-cycle interpretation of saving. The life-cycle model is one of the major theories used to explain consumer decisions. It was proposed originally by t Modigliani and Brumberg (1954, 1979), and it looks at individuals or couples using up their consumption over a lifetime. The simplest explanation of this model is the people earn an income from their labor only until they retire, but their consumption behavior does not change over their lives. And because of this, they will want to save during their working years. This is something that happens a lot within many economies, and it plays a critical role in the growth, development, and sustainability of these economies. Hence, people are net savers during their working years and net dissavers during retirement. For instance, the elderly will start selling their assets to finance their consumption expenditures. 

But it only becomes a cycle because chances are even the buyer now will sell it later for the same reason. Provided there is neither income nor population growth, the provision for old age will be enough to support a constant ratio of consumption to earnings with an economy. This means we are looking at saving as a way to keep up with the same lifestyle throughout the lives of those involved.

There is a simplified model version of this model, which states that the saving rations need to go up by two percentage points for each point surge in the growth rate. This prediction is consistent both with the cross-country relationship between saving and growth, and also a decrease in the saving rates. This approach is also linked to the slowdown of productivity with industrial nations, as stated by Modigliani (1993).

The precautionary view

Why do households save? One, because they want to finance their life after retirement or use if for other planned activities in their life – it could be to buy a car or go on a dream vacation. This completes the constant level of consumption over their life cycle. And two, they save because they want to protect themselves against unexpected shocks through the life-cycle. There are many risks over a lifetime, most of which we cannot avoid and which can cause consumers to lose their income. Therefore, these unforeseen circumstances require them to create a precautionary saving plan. Spending and saving form part of the biggest decision consumers have to make. And by studying these patterns, economists can create stronger foundation for economic sustainability. 

Author: James Hamilton