The commentary examines how the main components of aggregate expenditure in the UK, US and Euro-area have responded to the 2007 financial crisis.
Fluctuations in aggregate spending tend to cause fluctuations in real output and employment. The most commonly accepted reason why is that prices and wages are not instantly changeable. Consequently a surge in demand will, initially at least, tend to be met by increased output; and a drop in demand, by a fall in output.
Aggregate expenditure on currently and domestically produced output is conventionally divided into four broad categories:
- Consumption expenditure, which consists mainly of expenditure by households on non-durable items such food and entertainment, and, in most National Accounts, on durables such as televisions and furniture.
- Investment expenditure, which consists of expenditure on capital goods such as newly produced buildings and machinery. In the data presented here investment expenditure includes both private sector and government expenditure.
- Government expenditure, which here consists of so-called current expenditure. This is expenditure by governments for some goods or services which are non-capital items. So it includes items such as the salaries of the police and the judiciary, or drugs for NHS. [It does not include so-called ‘transfer payments’ such as the State Pension since this does not involve the purchase of any currently produced good or service. These items affect spending through the consumption expenditure of those who receive them.]
- Net Exports, which is the difference between the value of exports and imports. Expenditure by foreigners on domestically produced goods and services is clearly a demand for domestically produced goods and services. Hence exports add to aggregate expenditure on such goods and services. But to the extent that the previous three items are expenditures on foreign goods and services (imports) they need to be subtracted if we are calculating expenditure only on domestically produced goods and services.
Aggregate expenditure – and the items that comprise it – can be expressed in nominal terms, i.e. as the amount of expenditure in £s at the time, or in real terms, i.e. the volume of goods and services that that amount of nominal expenditure would have bought if prices in a base year had been in operation. For most purposes – such as assessing the standard of living – expenditure in real terms is the appropriate measure. The data we present are in real terms.
For most countries, consumption expenditure is the major component of aggregate spending and net exports a minor component. And for most countries the investment component exhibits the greatest short-run volatility. The proportions of each of these aggregates in UK GDP illustrate these points.
Consumption expenditure has generally accounted for 60% of aggregate UK expenditure over the last 60 years; investment expenditure around 20%; current government expenditure has generally declined from about 30% to 20%; and net exports, a small and, in recent years especially, a negative proportion.
Since the mid-1970s the proportion of UK aggregate spending accounted for by consumption has tended to rise gently, and the proportion accounted for by government current expenditure has tended to fall.