Duesenberry's theory of consumption in an age of financialisation

This paper illustrates how the incorporation of psychological and cultural elements into macroeconomic theory can have positive explanatory payoffs. In his 1949 book, Income, Saving and the Theory of Consumer Behavior, the economist James Duesenberry developed a theory of consumption behaviour incorporating a rich tapestry of socio-cultural factors in order to explain household consumption behaviour at the individual and the aggregate level. This theory broke with orthodox neoclassical consumer theory which assumed atomised perfectly rational, cognitively inerrant utility maximising agents. Duesenberry developed a taxonomy of distinct motives for consumption that could be satisfied by a culturally determined ranking of the quality products. He posited that households were governed by habits and were subject to a demonstration effect. Further, he held that the tendency to increasing consumption is due to households' socialisation to consumerism, where an ever-higher material standard of living is the overriding self-esteem satisfying goal. Duesenberry's relative income hypothesis as it is now known, suffered the lamentable fate of being both misinterpreted and neglected. We argue that Duesenberry's theory can serve as a central component of a theoretical framework which could provide an account of financial fragility in a contemporary financialised economy. The framework is augmented and thereby strengthened by the incorporation of two other relatively neglected theoretical developments in economics. One is Joseph Schumpeter's Creative Destruction Hypothesis, and the other is J.K. Galbraith's Dependence Effect. With these augmentations in place, combined with the substantial slackening of constraints on household borrowing due to financial sector deregulation, this theoretical framework presents us with a macroeconomy that is fuelled by debt-financed consumption expenditure. As such, households become more vulnerable to sudden interest rate and income shocks, which serve to render the macroeconomy more fragile.