In a much-anticipated speech on Friday, Fed Chairman Ben Bernanke invoked a favorite metaphor of economists to describe the current, critical period in the recovery. Now is the moment, he said, that a “handoff” must occur between temporary boosts to growth, like government stimulus, and more lasting drivers, like spending by consumers and businesses. Bernanke stressed that the handoff was underway, but he conceded that “growth has been proceeding at a pace that is less vigorous than we would like.”
The particular source of his anxiety was consumer spending, which the chairman worried was flagging amid high unemployment, sideways home prices, and the debt we all took home from the recent subprime party. It comes as no surprise that consumers would weigh on the Fed chairman, of course. While it’s certainly possible for the economy to grow without consumers pitching in, it’s much, much easier when they do. Because consumer spending accounts for about 70 percent of GDP, a 2 percent increase raises GDP growth by almost 1.5 percentage points. By contrast, it would take a roughly 10 percent increase in investment—spending on things like factories, equipment, and new-home construction—to boost GDP growth by roughly the same amount, because investment only accounts for about 14 percent of GDP.
Unfortunately, even under relatively optimistic scenarios, consumer spending isn’t likely to impress anybody over the next several years. Instead, the backdrop for Bernanke’s comments is a debate about whether spending by consumers will fall only modestly relative to the pre-crash days, or whether we’ll see a pronounced drop that weighs on the economy’s back like a large, belligerent primate. Here’s hoping for mediocrity.
It’s not hard to find proponents of the more upbeat scenario (such as it is) among private-sector economists. But the Obama administration has made the case for it with more rigor and precision than just about anyone around. The administration’s model, laid out in the Economic Report of the President in February, assumes that three basic factors drive the decision to save rather than spend: wealth, unemployment expectations, and access to credit. During the boom years, the housing market boosted wealth, jobs were plentiful, and credit flowed easily (which is of course the definition of a credit bubble). Not surprisingly, Americans saved little and spent briskly.
Once the bubble burst, this process went into reverse. The saving rate—the fraction of income people choose to save—steadily rose from about 1-2 percent before the recession to around 6 percent in the first half of this year. A rising saving rate means consumption is growing more slowly than income. Put differently, consumers have been a drag on the economy.
Here’s where the tentative optimism comes in: While unemployment is likely to stay uncomfortably high for the foreseeable future, wealth is gradually recovering (as the stock market rises) and banks are extending more credit. The combination of those things should stabilize the saving rate at 6 percent, or even bring it down a bit. That means consumer spending should grow at about the rate that incomes grow, or slightly better, going forward. “We were in a period in which people had to ratchet down their level of spending,” says Chris Carroll, an economist at Johns Hopkins University, who drafted the White House report on consumer spending while at the Council of Economic Advisers. “We may be seeing the end of the period where it has to be ratcheted down.”
Of course, the bad news is that incomes aren’t likely to grow very impressively over the next few years, so consumer spending won’t either. “In my view there’s not much reason to think that households are going to power us out of current slow period,” says Carroll. But at least they won’t be exacerbating the problem.
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