U.S.: Recession? Consumers Aren't Buying It

Their spending, fueled by tax and interest-rate cuts, will likely continue

If the U.S. is in a recession, someone forgot to tell consumers. True, they're not binging as they were a year ago, but households are hanging in there, and a recession has never occurred without an outright drop in consumer spending. Despite all the dour economic headlines, the latest retail sales data suggest that the will to spend is still strong.

But do consumers have the means to keep on buying? That's the crucial question for the outlook. Their finances have been hit by the plunge in stock prices, a weaker job market, rising debt burdens, and a negative saving rate. Yet despite those hammer blows, buyers seem to have the wherewithal to keep shopping.

For one thing, rising home values are offsetting the drop in stock portfolios, and wages are still increasing faster than inflation, adding to household buying power. Also, the decline in the saving rate was concentrated among upper-income households. Lower-income families actually have increased their savings from the pace of the early 1990s.

Moreover, finances will get a lift from the tax rebate and cuts in payroll withholding rates. And financing costs will drop as a result of the Federal Reserve's cuts in interest rates.

While laid-off workers are facing tough times, and that economic pain should not be minimized, the consumer sector in general seems healthy enough to buoy the economy in the second half. Increased spending there should offset the brakes on growth from declining capital outlays and an inventory correction. Those two drags could cause a drop in second-quarter real gross domestic product, but growth should firm up as long as consumers soldier on.

SHOPPERS HELPED TO SUPPORT economic growth in the spring, according to the data on retail sales and food services, the Commerce Dept.'s new measure of shopping activity based on its revised classification system. Sales surged by 1.4% in April and edged up another 0.1% in May (chart). Sales at gasoline stations rose strongly, mostly reflecting higher gas prices. But stores selling furniture, groceries, sporting goods, and hobby equipment also posted large May gains.

The increases in April and May retail buying suggest that real consumer spending is growing at an annual rate of about 1.5% in the second quarter. That would be the slowest pace in nearly six years and far below the shop-till-you-drop record pace of 7.6% set in the first quarter of 2000. The slowdown is probably temporary, though, and spending should pick up somewhat once taxpayers start receiving their rebate checks.

Consumer spending hasn't declined outright, in part because wage growth remains quite healthy even in the face of rising layoffs. In the first two months of the second quarter, nonfarm payrolls fell an average of 101,000 per month, but wage growth still climbed 4.3% from the year before, or about one percentage point faster than inflation, even with the recent jump in gas prices.

To be sure, the unemployment rate will increase as the year wears on and as companies cut labor costs to salvage profits. But the job market may not loosen enough to make much of a dent in wage growth, which tends to lag behind the ups and downs of real GDP. And once the economy picks up, businesses will be looking to hire workers again. Increased labor demand will keep wages growing at a healthy pace that will continue to support consumer spending.

EVEN SO, households aren't immune to news about corporate job cuts. And some may be curtailing spending in order to save more for a rainy day. The U.S. saving rate has been falling sharply since 1998 and turned negative in mid-2000. On the surface, that suggests that consumers have little cushion against hard times.

But fears of cash shortages may be exaggerated. A Fed study by Dean M. Maki and Michael G. Palumbo shows that the drop in the saving rate was concentrated in the households most able to cut back on savings (table). According to the study, households in the top 20% of income-earners--with annual incomes of about $79,000 or more--reduced their saving rate from 8.5% in 1992 to -2.1% in 2000. The next highest 20% also saved less, but their saving rate remained positive. Surprisingly, households in the bottom 60%--making $50,000 or less--are saving more of their income than they did eight years ago.

One reason that upper-income families cut back is that they accumulated new wealth from the capital gains of their considerable financial assets. They didn't need to save from their current income to raise their net worth because the soaring stock market was doing the job for them. Lower-income people, on the other hand, hold fewer financial assets. So they may have recognized the need to save more as a hedge against hard times. Viewed in this way, both sets of households acted rationally, with the net result that the overall saving rate dropped sharply during this expansion. Despite the decline, the most economically vulnerable households have some additional financial leeway.

THAT COULD BE IMPORTANT during this rough economic patch. New claims for jobless benefits have risen over the 400,000 mark, a level usually associated with recession. And the delinquency rate for some of the riskiest mortgages is rising.

In addition, households are carrying a record debt burden, which puts a strain on monthly budgets. Installment credit jumped $13.9 billion in April, led by a huge advance in revolving debt, which includes credit cards. Total debt outstanding equals 21.9% of disposable income, the highest ratio ever.

Because the Fed no longer breaks down the credit numbers, it's difficult to say whether debt is rising because consumers are having trouble paying down their credit-card bill or whether households feel secure enough about their economic future that they aren't worried about taking on more debt.

One sign that consumers still are upbeat is the continued increase in home-buying. In mid-June, applications for mortgages to purchase a home were at their highest level in six months (chart). Homeownership is a key source of consumer wealth, and home values have been rising even as stock prices have tumbled.

While news on the consumer front is reassuring, that does not mean the outlook is free of risks. A plunge in stock prices or a sharp deterioration in the labor markets could sink consumer confidence, and spending could drop. But with stimulus coming from both tax cuts and lower interest rates, neither outcome seems likely in the second half. And bear in mind that consumer spending accounts for two-thirds of real GDP. So if anyone is going to spread the word about recession, consumers will be the ones shouting the loudest.

By James C. Cooper & Kathleen Madigan

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