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Photo: Reuters
Photo: Reuters

How bad economic news hits consumption

Steady release of salient bad economic news can cause a sharp and enduring decline in consumption, finds a new study

Contrary to the predictions of a V-shaped recovery, consumption seems to be recovering much more slowly in China than expected. This has raised concerns that reduced spending after lockdown curbs are eased could delay economic recovery.

The spending cuts need not always be motivated by income shocks. A National Bureau of Economic Research (NBER) working paper suggests that bad news or seemingly bad news can cause a sharp and long-lasting decline in consumer spending, regardless of the actual conditions. In this study, Mark Garmaise of the UCLA Anderson Graduate School of Management and others observe the effect of local jobless rate announcements on discretionary spending of households across 50 US counties from January 2012 to December 2018.

They focus on announcements that suggest increases in unemployment to record levels, as they are likely to be particularly salient for consumers and are more likely to receive media coverage. The experiment shows that news of a rise in local unemployment rate to a 12-month high leads to a 2% drop in discretionary spending in the two weeks that follow the announcement. Interestingly, the announcement of a “near" record unemployment rate has no effect on spending.

The announcement of a false record—a record-high that is later revised lower—has the same impact on consumers as an actual record-high unemployment rate. This suggests that consumers do not necessarily respond to the actual unemployment rate, but to the announced rate. It also affects financing behaviour, the authors find. The announcement of unemployment rising to a 12-month high can lead to a 3.6% dip in credit card repayments and fall in cash withdrawals. This may be because adverse economic news leads to higher uncertainty.

The dip in consumption is larger for poorer, less-educated households. More worryingly, consumption can remain low for 2-4 months in response to the news, the study shows.

Also read: Spending Less After (Seemingly) Bad News

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