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April 2009 Quarterly Forecast
> Consumers Are Cautious, but Not in Panic
Levan Efremidze, UCLA Anderson Forecast
Households turned cautious last September, largely due to the sharply rising economic uncertainty stemming from the Wall Street-Washington’s juggling of the financial crisis and a real burden of ballooning personal debt. Since then, the personal savings rate at the national level (separate East Bay savings rates are not available) surged to 4.2% in the first quarter of 2009 (Figure 1).
Figure 1
Sources: BEA, UCLA Anderson Forecast
When consumers face a fear of job loss, they start saving more. While a high savings rate is good for the long-term capital accumulation and consequently for the growth rate of the nation, this sudden rise of the savings rate could cause a phenomenon called “Thrift Paradox,” the term coined and explained by John Keynes during the great depression. If everyone tries to save more, such coordinated action in the short-run will drive down the demand for products and services, thus causing worker layoffs and a fall in overall income, in effect resulting in less savings. But how severe is this problem at present? The local East Bay data on retail employment and the first quarter U.S. GDP data answer this question.
Figure 2. U.S. Consumer Spending
Sources: BEA, UCLA Anderson Forecast
In the first 12 months of this recession, the East Bay retail lost 9,000 payroll jobs, but added about 700 jobs during the first quarter. Another glimpse of the consumer resilience is confirmed by the recent U.S. GDP report (see Figures 2 and 3). Within the overall dismal picture of the economy -- reporting a -6.1% drop in first quarter GDP, we also read some encouraging developments in the category of personal consumer expenditures. The spending here improved by 1.5% as a contribution to the GDP growth from the previous quarter, mostly on durable goods and services, each contributing 0.6%. How hopeful should we be about these healing signs?
The current recession is already longer than the average of the previous ten post-WWII recessions by 5 months. With this measure it should not be a surprise to see consumer spending reviving, but usually housing is the sector that recovers along with durables – a trend we do not see this time around. The housing bust as observed by sliding construction employment and housing starts is still a big drag to the East Bay economy as well as to that of the nation.
Figure 3.
Sources: BEA, UCLA Anderson Forecast
One way to explain how individual consumers are coping with relatively cheaper housing prices and a deflating overall price level could be the reallocation of family budget shares away from housing and more towards consumables, such as durable goods, nondurables and services. In economic terms, relative price changes within the consumer basket of goods produce the so called “income effect,” which means that real purchasing power of the same amount of nominal income rises if some of the goods become cheaper. This income effect could at times overpower the “substitution effect,” a tendency to consume more of the relatively cheaper goods and less of the relatively expensive ones. When income effect dominates, it becomes possible to consume more of all goods. This may also allow room for a higher savings rate. At the aggregate level economic connections become much more complex and this question would require more investigation.
The U.S. economy during the last 20 years has been characterized by rising consumer spending and its share in aggregate spending peaked at 71% of GDP in June 2008. When the economic downturn accelerated in September and consumption started to fall, the logical evaluation called for the eventual adjustment away from consumption and imports towards the restoration of savings, and more exports and manufacturing. Maybe, given the availability of much cheaper housing than before, it will be possible for consumers to maintain spending as well as increase savings. This is an important question for the future of retail and all other consumer driven sectors. The outcome is hard to predict due to the multitude of factors and an unprecedented magnitude of home price declines in many U.S. markets.
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