The Federal Reserve has now lowered interest rates 17 times in the past two years, pushing them to levels not seen in decades. Yet the prime object of these actions, the U.S. consumer, whose purchases account for two-thirds of national output, has been conspicuously unresponsive to their effects.
To be sure, the public did start to loosen its purse strings in the first quarter of this year, when real consumer spending moved higher at a respectable 5% annual rate after posting no increase at all in the final quarter of 1991. But since then, inflation-adjusted household outlays appear to have crept higher at a minuscule 1% pace.
Since easier money is virtually the only policy lever the government possesses to stimulate consumption (the huge deficit precludes much fiscal stimulus), the key question is why consumers haven't responded in kind. The common explanation is that they are inhibited by sluggish income growth and the need to reduce high debt loads. But economist Rosanne M. Cahn of First Boston Corp. thinks changing consumer buying attitudes are also a big factor.
Cahn notes that consumer surveys indicate that low prices have become more important than low interest rates as incentives to buy. In 1986, for example, when both interest rates and inflation were relatively low, the lure of low rates was strong. But since then, low rates have steadily lost ground to low prices as a spur to consumption (chart).
One reason for this, of course, is the phasing-out of interest deductibility for most borrowing since the passage of the Tax Reform Act of 1986. By reducing the incentive to use credit, this measure also reduced the consumer's sensitivity to rate changes. At the same time, however, notes Cahn, producers have come to rely more and more on temporary price cuts to spur demand. Indeed, the surge in consumer spending in January and February of this year was largely inspired by price-slashing by auto makers and general merchandisers seeking to move bloated inventories.
The problem with this tactic, notes Cahn, is that "its growing use has made consumers aware of their aggregate power--and increasingly prone to exercise their ability to cause price declines by refusing to buy at other times." And the need to resort to frequent discounting leads to greater cost-cutting efforts by business, which means reduced hiring and income growth. In this no-win situation, says Cahn, monetary ease by the Fed has lost effectiveness.