Long-term Fluctuations and Structural Changes in Consumption
No.236
August 2005
Senior Research Fellow Naoki Nagashima
ABSTRACT
In the face of deteriorating fiscal health, the debate on raising taxes is heating up. At the same time, lasting growth for the future of the Japanese economy is greatly dependent upon individual consumption trends. To what extent tax increases restrain consumption is dependent to a certain degree on income and price effects. Regarding both consumption as a whole and itemized consumption expenditures, this report will estimate the various values of elasticity and examine the implications on the tax system. The results can be summarized as follows:
- On reaching the fall of 1998, the trend in income and general prices changed from positive growth to decline; this was accompanied by structural alteration as well, as the value of income and price elasticity also showed a great deal of change. Compared with the period before fall 1998, both the income effect and price effect (general price effect) became much greater thereafter. Seen in this light, there is a tendency for consumption to react more strongly to a decrease in income and prices rather than an increase.
- Even if the rate of decrease in actual purchasing power is the same, the effect of a decline in income is greater than that of a rise in prices. In light of this, a money illusion is clearly at work. If consumers believe that an increase in income tax (e.g. the abolition of tax reductions) causes a decrease in nominal disposable income, and an increase in consumption tax causes a rise in general prices, the effect of a tax increase on consumers is greater in regards to income tax than consumption tax.
- In terms of itemized consumption, previously the income effect on consumption related to clothing, food, and housing was small. However, the effect on this consumption has increased rapidly since 1998, and has risen above that of cultural and recreational consumption. Facing a decrease in income, since 1998 it is estimated that household budgets have responded by cutting back on this daily, fundamental type of consumption.
- In light of the fact that it is difficult to respond to income and price fluctuations, there exist some fields with a high level of autonomy. Since the fall of 1998, cultural, entertainment, and durable goods consumption-types previously seen as selective-have become areas of autonomous consumption. The level of consumption in these areas are influenced more by supply side factors, such as the introduction of new services and products, rather than by income and prices; furthermore, expansion of consumption in these areas is closely linked to expansion of consumption as a whole.
CONTENTS
- Problem awareness
- The concept of consumption emphasis
- Consumption and income/prices: movements in the last 30 years
- Observations on the money illusion
- Estimating the income effect and price effect
- Conclusions and implications
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