Wednesday, March 11, 2009

The Consumption Decline: Recognition or Necessity?

The amount of disposable income that Americans have had available to spend has continued to increase since last August, while the amount they have actually spent has been dropping. This suggests that the fundamental cause of low consumption spending is consumers’ recognition that their homes and businesses are worth less. It also suggests that consumer spending may be headed even lower.

The chart below graphs monthly personal disposable income and consumption expenditure since July 2008, both adjusted for inflation. The former has been rising since August and the latter falling most of the months since June.

Personal consumption expenditure measures the amount spent by households on goods and services. It comprises about 70 percent of total spending in the economy. Thus, it is important to understand why consumption spending has fallen so much in the last six months.

Personal disposable income measures the income that households actually receive (net of taxes) from their jobs, from dividends and net interest on investments, and from government transfers like Social Security. It is income households have available to spend or save.

If severe enough, reductions in personal income would require households to spend less on goods and services. But for several reasons, personal income has actually been rising despite the recession: Millions of people (so far) remain employed and paid well; corporations with slack earnings continue to pay their dividend; unemployment insurance payments have been rising; and Social Security payments were increased.
Many people have reduced their purchases of goods and services in spite of rising disposable incomes because they recognize that their homes are worth less, any shares of a business they own are worth less (despite the business’s continued dividend), and those still employed are concerned that they may be part of the next layoff.

The year 2008 finished with a lot of bad news that legitimized these concerns. But even with such a modest starting point, 2009 has had plenty of bad news of its own, including a 20 percent (or more) stock market decline and a further sharp reduction in employer payrolls. It seems that consumers could legitimately cut their spending yet again in February, March and April.


niknaknoo said...

Rising disposable income? Have pay increases been keeping up with inflation over the last couple of years?

The fact that the US economy is based on 70% consumption says it all. The US population are consuming more than twice what they are producing!!

It's no wonder the country is trillions upon trillions in debt.

Sheng said...

This is an age of insanity: bad economics floating around sounding like good economics. Today a WSJ journalist says the rising savings rate will hurt the economy in the short run, but will benefit it in the long run; because of this, the government has to borrow from people to spend for them.

This only holds when people stuff their money under the mattress. Otherwise there's no reason to assume the money saved will sit idle. And these saved funds should earn high expected return at this moment and will be put in greater use, -- unless, of course, governments have snapped up the opportunities that the private capital can invest. And we know the government will be less efficient.

Have we noticed that the market cheers whenever the government takes some intervening actions? The loudest complaints I hear are that the government hasn't acted swiftly enough. This is a dangerous signal to me that the moral hazard has deeply sunk in. Now Europe is more disciplined in their fiscal policies and is ironically despised. We see the regime switched where U.S. becomes more like old Europe, and Europe more like old U.S.

In terms of market interference, these countries can never compare to China in its implementation speed and resolves. Chinese government is more efficient in this regard once it thinks it has the right policy. Time will not be long when people begin to say: oh, China!