Question

The Federal Reserve reported that household wealth decreased by \(\$ 2.4\) trillion or \(\$ 21,000\) per household in the third quarter of \(2011 .\) This drop is the steepest since 2008 and the second consecutive quarterly drop. Foreclosures lowered household debt slightly but credit card debt increased. Many households are struggling to buy the essentials and spending on food has decreased. Separately, the Bureau of Economic Analysis reported that consumption expenditure increased by \(\$ 39\) billion in the third quarter of 2011 Sources: The New American, December 11,2011 , and the Bureau of Economic Analysis What factors might explain the actual changes in consumption expenditure and wealth that occurred in the third quarter of 2011 ?

Short answer

Factors include decreased household wealth, increased credit card debt, and essential goods spending, which collectively influenced consumption expenditures.

Step-by-step solution

Understand the Financial Terms

Identify the financial terms involved: household wealth, consumption expenditure, foreclosures, credit card debt, and essentials. Household wealth refers to the total assets owned by households minus liabilities. Consumption expenditure is the total amount spent by households on goods and services.

Analyze the Reported Changes in Wealth

Note that household wealth decreased by \(2.4 trillion or \)21,000 per household, marking the steepest decline since 2008. This indicates a significant loss in wealth for families, likely affecting their spending behavior.

Examine Household Debt Trends

Foreclosures have slightly lowered household debt, which means people had fewer liabilities from mortgages. However, credit card debt increased, showing that households may be relying more on borrowing for daily expenses due to reduced wealth.

Consider Spending on Essentials

Many households are struggling to buy essentials, and spending on food has decreased. This implies that increased financial strain is leading families to cut back on necessary expenditures, possibly due to either reduced income or higher prices.

Evaluate Consumption Expenditure

Despite a decrease in household wealth, the Bureau of Economic Analysis reported a $39 billion increase in consumption expenditure. This may seem contradictory but can be partly explained by increased credit card usage and possibly delayed impact of wealth changes on spending patterns.

Synthesize the Factors

The decrease in household wealth could lead to reduced consumer confidence and spending. However, increased credit card debt suggests that consumption expenditure temporarily increased as households borrowed more to maintain their standard of living. The pressure to buy essentials while facing reduced wealth also contributes to complex changes in overall consumption patterns.

Key concepts

household wealth

Household wealth represents the total value of financial and real assets owned by households, minus any liabilities. This can include savings, investments, properties, and other valuable assets. In the third quarter of 2011, there was a significant decrease in household wealth by \(2.4 trillion overall, and \)21,000 per household. This decline marked the steepest drop since 2008. Such a loss in wealth can have substantial impacts on families.

When household wealth decreases, families might find it challenging to maintain their living standards. They may cut back on spending, delay large purchases, or even have to dip into savings, if they have any. The loss can also shake consumer confidence, making people less likely to spend freely.

The decline in wealth often leads households to re-evaluate their financial priorities and strategies, potentially increasing household stress and reducing overall economic activity as people become more cautious with their expenditures.

consumption expenditure

Consumption expenditure refers to the money households spend on goods and services. In the context of 2011, despite the sharp decline in household wealth, there was a reported $39 billion increase in consumption expenditure for the third quarter. This might seem counterintuitive at first.

A closer examination reveals that even when household wealth decreases, consumption expenditures might temporarily rise. During times of financial stress or uncertainty, one reason could be increased borrowing to cover daily expenses, leading to higher credit card debt. Additionally, consumption expenditure can also include essential items that families cannot easily forego, such as food, utilities, and healthcare. Even as families struggle with decreased wealth, they might continue spending on these essentials, sometimes even at the expense of accumulating more debt.

Furthermore, there may also be a lag between the loss of wealth and a decrease in consumption expenditures. Families might initially try to maintain their usual spending habits, hoping that the financial situation is temporary. Only after prolonged financial strain might they drastically cut back on spending.

household debt

Household debt encompasses all the liabilities a household has, such as mortgages, credit card balances, and personal loans. In the third quarter of 2011, the dynamics of household debt were particularly noteworthy. While mortgage debt (partly due to foreclosures) lowered slightly, credit card debt increased. This increase suggests that families were relying more heavily on borrowed money to cover their daily needs.

The rise in credit card debt could be due to several factors. First, as families faced a significant drop in household wealth, they might have turned to credit cards to manage short-term cash flow problems. This might include covering essentials like groceries, utilities, and healthcare. Second, increased debt can also result from larger economic conditions like stagnant wages and rising living costs, making it harder for households to balance their budgets without resorting to borrowed funds.

However, higher credit card debt is not without its consequences. It comes with high-interest rates, which can compound the financial stress as households struggle to pay back their debts. This can create a vicious cycle, where debt begets more debt, further eroding household financial stability and potentially leading to future financial crises.