The Impact of Wealth and Sentiment on Consumption: Before and After the Great Recession

I study the impact of consumer sentiment and the wealth effect on aggregate U.S. consumption before and after the Great Recession. First I will introduce a background of the 2008 financial crisis and some major factors leading up to it. I will discuss both the Michigan Consumer Sentiment index as well as the Conference Board’s Consumer Confidence index. I will also discuss several measures of net worth relevant for my study. Second, I will discuss the relevant literature and the main findings that correspond to my thesis. Third, I will present the methodology used for my thesis, and the several types of specifications included to adequately test my thesis question. Next, I will present the empirical results found in the various regressions run in both levels and first-difference and their interpretation. Overall, I find no asymmetric response of consumption to changes in wealth and sentiment. Therefore, aggregate consumption tends to respond the same to the same size increase or decrease in the two main explanatory variables. Additionally, a significant structural shift in aggregate consumption is evident due to the Great Recession. The consumption function on average is estimated to have shifted downward by about $43.791 billion as a result of a near demise of the American economy. After further analysis of the data, another structural shift in aggregate consumption was realized at around 1998. In this case, the consumption function shifted upwards an average $11.557 billion, which can very likely be explained by the repeal of the Glass-Steagall Act allowing loans to be given out to nearly anyone regardless of their financial stability. Ultimately, consumer sentiment, wealth and disposable income all have a significant impact on aggregate consumption.