The onslaught of chart porn begins with the changes in the US personal savings rate for the last five years, updated to reflect Monday’s income and outlays report from the BEA:
The decline in the December savings rate, from 5.5 to 5.3 per cent, took place in a month when income climbed impressively, which meant a sharp increase in spending, the sixth consecutive month that figure has climbed.
Back in October and November of last year, one of the reasons that cautious optimism returned to the US economy was the possibility that household deleveraging was far enough along that it could continue, perhaps at a slower pace, even while consumers felt comfortable spending again.
With government’s contribution to the economy declining and corporates continuing mostly to sit on their cash piles, consumption would have to carry a heavy burden for pushing the economy forward.
This, we thought, was a plausible justification for the December tax cut compromise — which, poorly designed though it was, at least would prevent a contractionary shock to household incomes that would force the savings rate upward again.
Thus far, it seems, consumers are playing their part — increasing spending and continuing to deleverage. Greg Ip wrote in November that the ratio of household debt to disposable income had declined from its 2007 peak of 135 per cent to 123 per cent in the middle of last year. And since then it has fallen further to 118 per cent, which you can see in this chart from the San Fran Fed:
At the same time, if you look at a breakdown (via EconomPic Data) of last week’s GDP numbers, it’s clear that personal consumption is indeed what largely drove the economy in the fourth quarter:
(Yes, there was also a big contribution from declining imports, but James Hamilton explains that this positive contribution should be interpreted as having been offset by declining inventories, as these two variables have tended to move inversely of late, which is likely not a coincidence.)
This seems exactly like the scenario everybody was hoping for: a recovery that’s driven by rising income and demand, taking place even as households keep deleveraging.
But as ever, the story is a lot more complicated, especially when you start to think about how this plays out beyond the next few quarters.
Here’s a look at the movements in the savings rate going back fifty years. You can see that even after the post-2009 surge, it’s now only roughly in line with what we saw in the 1990s — and actually well below its normal level for the thirty years before that:
In other words, the recovery can’t be just a consumer story forever. That spending is outpacing income is a welcome boost to the economy for now, but certainly nobody would think it healthy for the savings rate to fall again to the absurd, sub-1% levels it reached in 2005.
At some point, the recovery will need help from business investment (including higher employment) to be sustainable. And surely Tim Duy has a point when he writes that an element of global rebalancing needs to play a big role as well — a higher savings rate would help the US reduce its current account deficit and allow net exports to pull more weight.
As you may have guessed, there are additional complications.
One is that much of the deleveraging is happening through defaults on mortgages and consumer loans, as Mike Konczal has explained. This imposes both a human and economic cost, though we admit to being unclear on the magnitude of the latter. Konczal has posted this chart from a Brookings presentation:
The chart is only updated through mid-year 2010. But although the pace of foreclosure activity tailed off at the end of last year because of legal scrutiny, it remained high — and was still the primary cause of declining negative home equity.
Another issue is that consumption is now more susceptible to the vagaries of asset markets than it normally is. Or it likely is. The main reason, consistent with the first point, is that it seems wealthy households are primarily responsible for the recent spending bump.
Here’s Bloomberg Businessweek:
Those ordinary Americans who have jobs worry about holding onto them, and they expect few if any increases in pay as the recovery inches forward. For upper-income households, it’s a different story, says Michael Feroli, a former Federal Reserve economist who is now chief U.S. economist at JPMorgan Chase in New York: “They’re the ones benefiting the most from the stock market rally, and they’re spending.”
Consumer spending accounts for about 70 percent of the economy, and the uneven pattern in household expenditures helps explain why Fed policymakers will likely keep interest rates near zero while carrying on with a second round of Treasury purchases aimed at getting credit flowing again. Unemployment averaged 9.6 percent last year, the highest rate since 1983, even as the expansion gathered speed. Feroli estimates the top 20 percent of income earners account for about 40 percent of spending. Dean Maki, chief U.S. economist at Barclays Capital in New York, puts the figure at closer to 50 percent.
To summarise, wealthy households are spending but might stop if their stock market gains reverse, while non-wealthy households are keeping an eye on their wallets and deleveraging primarily through defaults.
There’s more happening and that’s a simplistic interpretation, an exaggeration — but it may not be much of one. (It’s hard to get better data for this kind of income-based breakdown, as the latest annual consumption expenditure survey from the BLS only has numbers through the end of 2009.)
As for the policy implications of all this, well, it’s complicated.
There was an excellent debate within the blogosphere in early January about whether the need for household balance sheets to delever was even to blame for the sluggish recovery. (We recommend Konczal, Ryan Avent, Mark Thoma, and David Beckworth. One side believes that the need for households to delever was indeed responsible, which means fiscal policy to plug the gap would be required. The other side believes it was a problem of excess demand for money, meaning that monetary policy — whether through NGDP- or price level-targeting or more asset purchases — would be best. Never mind, damn it: we said it was complicated.)
We don’t really know, but with the tax cut compromise behind us and the Fed likely to be on hold until later this year, our own guess is that much more help from policymakers is unlikely anyway.
Which means we are left to hope that this consumer-driven growth will eventually lead businesses to start investing in capital and hiring — and the sooner the better, obviously.
With all the usual caveats about vulnerability to future negative shocks, there are some signs that this is happening. We’ve said before that there is more momentum towards a pickup in hiring than the recent payroll numbers suggest, and today’s ADP report is further evidence of that. James Hamilton cites this week’s favourable manufacturing and auto sales figures in addition.
But it’s still a bit early to know anything for sure. As for what’s next, all eyes on Friday’s employment report.
Related links:
An improving economic outlook – Econbrowser
Underappreciated data – Tim Duy
Balance Sheet Recessions, Foreclosures, and Consumer Spending – Rortybomb