Personal Income and Spending

There’s a new data release out this morning on personal income and spending. The highlights:

Personal income increased $75.2 billion, or 0.7 percent, and disposable personal income (DPI) increased $50.2 billion, or 0.5 percent, in January, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $76.7 billion, or 0.9 percent. In December, personal income increased $54.8 billion, or 0.5 percent, DPI increased $47.6 billion, or 0.5 percent, and PCE increased $64.2 billion, or 0.7 percent, based on revised estimates.

…The January change in personal income was boosted by several special factors… Excluding these special factors, personal income increased $37.6 billion, or 0.4 percent, in January, after increasing $48.3 billion, or 0.5 percent, in December.

While the headline figures are pretty good, below the surface I’m less happy about this report. Much of the gains in income were one-time adjustments, and eaten up by higher prices. Real income growth is still lower than I think we have a right to expect at this phase of an economic expansion; lately the trend annual growth rate has been in the neighborhood of only 2-2.5%.

Two measures of real (inflation-adjusted) income are shown in the graph below, along with consumer spending and savings. The dark blue line shows disposable personal income (DPI), which is all income (worker compensation, interest earnings, rents, dividends, etc.) minus taxes. The light blue line shows compensation only, which includes wages, salaries, and benefits paid to workers. The red line shows consumption spending, while the green line shows the personal savings rate.

Note: All series deflated by the PCE deflator. The effects of the one-time Microsoft dividend payout of December 2004 have been removed to better show recent trends.

While worker compensation grew nicely in the end of 2004 and first half of 2005, compensation growth has slowed markedly since then. The broader measure of income (DPI) has recovered from some bad months last fall, but has still been growing only modestly since then. Consumer spending continues apace, but, as has been the case for much of the past year, is being sustained by households drawing down on their savings, not by higher incomes.

Unless real incomes start to grow more strongly sometime soon, it seems very possible that consumer spending could soon start to slow. And that is one of the principal reasons that I’m not very bullish about the economy in 2006.