Prospects for Consumption Growth

In the comments, General Glut asks the salient question in the wake of today’s unemployment report: “How long until these poor jobs numbers (and the even poorer wage and salary numbers) start eating into US consumption levels?”

Good question! This is especially important when you consider that consumption spending (spending by households and individuals) makes up close to 70% of all spending in the economy. Whatever economic growth we’ve seen over the past 2 years has been all the result of increasing consumer spending.

Up to now consumption has remained strong even while wage income has barely grown thanks to three factors. 1) To some degree, households have been spending some of their assets such as houses (e.g. through taking cash out when refinancing); 2) There have been some temporary windfalls such as the tax rebates of 2001 and 2003; and, most importantly, 3) Households have increased consumption faster than their income has grown, simply by devoting a smaller and smaller fraction of their (stagnant) income to savings, and more of it to consumption.

All three trends seem destined to end soon. The last GDP figures may have warned of the beginning of the end of the recovery, in fact. But there are specific reasons why the three exceptional factors listed above are not likely to continue boosting consumption. 1) The refinancing boom is beginning to peter out, since mortgage rates have stopped falling for some time (so most people who were going to refinance at these rates already have), and house values may be nearing their peak. 2) There will be one more tax boost with refund checks that are a couple of hundred bucks larger for most families than usual in April and May, but after that no more tax boosts for the foreseeable future. At this point, our fiscal policy ammunition has been pretty much completely used up. 3) Savings rates are about as low as they can go. That means that there’s precious little room for households to further increase their consumption.

So, the job reports – not just number of jobs, but also how well they pay – matter a LOT to the future of this economic recovery over the coming year. A few more mediocre reports like this and it looks a sure bet that economic growth in 2004 will be slower than 2003, not faster.