The U.S. economy has always been characterized as a market-driven enterprise. Right now, the designation is more appropriate than usual. That's because two markets--stock and labor--will be critical in driving future consumer spending and, thus, the economy as a whole.
What worries some economists is that the stock and labor markets will drive the recovery right into the ground. Consumers could hold back in the second half, a result of their disillusionment with the stock market and jitters about a weakening labor market. Bear in mind that consumers have been the wellspring of demand over the past year, both through their purchases of goods and services and by their willingness to buy houses. If households reduce their spending, the recovery will struggle in coming quarters.
Right now, it seems unlikely that the stock and labor markets will bring down the recovery. The latest jobs report shows that the days of massive layoffs are over, and workers are reaping pay raises that still outpace inflation (chart). The prospects for the stock market are more problematic. Still, households began to take the hit to stock wealth back in 2000, and real consumer spending managed to grow by an impressive 4.2% in 2000 and an additional 3.1% in 2001.
At the same time, though, job growth and equity wealth won't be the rocket boosters for spending as they were back in the years prior to the 2001 recession. Without the extra fillips, consumer spending will grow as fast as aftertax income does, or probably by about 3% in the second half. That pace, while modest, is strong enough to keep this recovery on solid footing.
CORPORATE CORRUPTION isn't new, but the sheer number of cases today raises legitimate questions about its effect on consumer confidence. President George W. Bush recognized this risk in his speech on July 9. The misdeeds of Corporate America, he warned, "are threatening the financial well-being of many workers and investors." The President proposed tougher penalties for fraud and tighter oversight by corporate boards, but at this early stage, the financial markets were unimpressed with his agenda.
But just as shoppers mostly shrugged off the market declines of 2000 and 2001, they have basically taken the scandals in stride. Weekly store surveys indicate retailers did well in June. And vehicle sales rose to an annual rate of 16.4 million last month, up from 15.5 million in May. The steady advance in spending suggests the risk of a consumer pullback is still small.
A bigger, albeit less appreciated, danger from the corporate mess is the effect it is having on the dollar. Foreign investors view U.S. securities as less attractive now than they did last year, when the economy was officially in recession. The pullout of foreign money from the U.S. financial system is weakening the dollar, which has fallen some 9% on a trade-weighted basis since February (chart).
A weak currency leads to higher import prices. By June, prices of nonoil imports had increased for three of the last four months. The rise will allow U.S. producers of similar goods to lift their prices as well. After years of extremely low inflation, the U.S. could face a steady climb in prices, perhaps as early as next year. Rising inflation is a drag on household budgets, causing it to be the second-biggest economic concern for consumers.
CONSUMERS' BIGGEST WORRY, not surprisingly, is joblessness. That's why healthy labor markets are key to the consumer outlook. Rising job prospects can often offset household discontent over a falling stock market. The latest employment report shows the labor markets are improving, although hiring has been slow to pick up after the recession. Nonfarm businesses added 36,000 in June, on top of a 24,000 gain in May. But the Labor Dept. revised down its previous data, so payrolls this year have been basically flat.
Despite that, the June unemployment rate was only 5.9%, a low reading right after a recession. And given the falling trend in new claims for unemployment benefits, joblessness should remain below 6%. That's a turnaround from the end of 2001 when some forecasters expected the rate to hit 6.5% or higher this year.
Two other good signs for the job outlook: Temporary-help jobs increased by 9,000 in June, the fourth gain in a row. And businesses lengthened the workweek in June. Both trends are precursors to the hiring of more full-time workers. In addition, factory layoffs were much less severe in the second quarter than in the previous five quarters. And June factory overtime edged up to 4.3 hours, the largest amount in 1 1/2 years. Those data indicate that the manufacturing recovery continued to strengthen in June.
Thanks to the longer workweek and the increase in payrolls, aggregate hours worked in the economy rose slightly in the second quarter, the first advance since late 2000 (chart). The small gain in hours means productivity posted another good increase in the second quarter. But the rebound in work time suggests that businesses are beginning to rely partly on labor, not totally on productivity, to increase output.
THE UPSIDE of the continued productivity boom is that employees, on average, continue to enjoy healthy pay raises. In June, hourly pay for nonfarm production workers rose 0.4%, to $14.76. Add in the longer work time, and weekly paychecks are up 3.6% from the year before. Even with the runup in energy costs in the spring, real weekly pay grew about 2.1% in the year ended in the second quarter. The recent fallback in fuel prices suggests that buying power will advance further in the second half. The extra cash should support future gains in consumer spending.
Trends in the stock and labor markets won't just drive consumer spending. They'll also influence monetary policy to some extent. To be sure, the Federal Reserve will not cast itself as a savior for Wall Street. Short of a systemic financial crisis, don't expect the Fed to help out the stock market. But policymakers are well aware that declining equity prices reduce financing for capital spending and curb household wealth. So the stock market's fall will surely be a topic of discussion when policymakers meet four more times this year.
On the labor front, the Fed will probably wait for a clear downtrend in unemployment before it starts to raise interest rates toward a neutral stance in which rates neither promote nor hinder economic growth. Given the slow pace of new jobs, that move is a long way off. More economists are pushing their expectations of the first Fed rate increase into 2003.
By that time, corporate scandals will be old news--at least, that's the hope. However, with the labor market improving and the Fed still on the sidelines, consumers seem unwilling to let the corporate crime wave curtail their spending plans.
By James C. Cooper & Kathleen Madigan