U.S. households are spending less. Is it because their incomes are down, because they have less net worth or because there is a fundamental change in what economists call ‘tastes and preferences’?
The answer affects how the economy responds to different monetary and fiscal stimulus efforts, in the long term as well as the short run.
Lower current income clearly is a factor for many people. Nearly 13.2 million people were unemployed in March. Another 700,000 were discouraged workers — people without jobs who had not taken concrete steps to get a job in a specified period and hence were not deemed “unemployed” by the Bureau of Labor Statistics. Another 9 million were working fewer hours than they wanted to because of economic conditions.
On top of that, many salespeople have seen their commission income drop, and hourly workers are finding overtime scarce. So decreased current income plays a major role in lower household spending.
Then there is how people perceive their wealth. We have a standing joke in our family when annual property tax valuation notices come in. The one for our farm says the value from 2008 to 2009 increased by more than my entire income. I call my wife and say, “We are rich, let’s go out to eat tonight.” Two days later, the one for our house shows a drop equal to my college teaching income. “Honey, we are poor, how about mac and cheese tonight?”
Then our quarterly retirement fund statements show that, after subtracting intervening contributions, we still are up slightly from early 2007, before the stock market fell — not the 40 percent losses some friends report. “Hey, let’s grill steaks tonight, our retirement home won’t be a derelict boxcar.”
We joke, but people’s perceptions of how the values of their houses and financial assets are growing or shrinking powerfully influence how willing they are to spend right now.
Indeed, the apparent prosperity of the dot-com bubble of the late 1990s and the 2004-06 housing bubble owed much to people looking at their house valuations or mutual fund statements and deciding they could live a higher lifestyle. This “wealth effect” increased spending and lowered savings because people not only assumed their gains were irreversible, but that they would continue to grow.
Now the wealth effect is operating in reverse. Even people whose incomes have not dropped at all look at their balance sheets and feel poorer. They conclude that they don’t have the money to continue spending over the long term and cut back, even if their current income covers current spending.
Finally, there is the factor of “tastes and preferences.” During booms or bubbles, high consumption spending becomes a social norm. Talk around the watercooler centers on the new boat, big-screen TV or upcoming cruise.
During busts, the subject may switch to the big garden someone is going to plant this year or the consignment store that has really sharp used clothing at low prices. Mention a recent big-ticket purchase and you will be deemed a braggart.
It is hard to determine the exact mix of these factors at play right now. Over the long run, our society needs to consume less and save more to be healthy. So moves toward thrift are positive. But in the short run, reduced spending slows the economy further.
The problem is that there is no way government can manipulate continued short-run spending that transitions smoothly into greater long-term saving as the economy recovers. All we can do is hang on for the ride. It is likely to be very bumpy.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.