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Home Publications Blogs Beat the Press Consumer Spending Follows Predictable Pattern, Surprising Economists

Consumer Spending Follows Predictable Pattern, Surprising Economists

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Saturday, 12 June 2010 07:17

It would be nice if the media didn't feel the need to rely almost exclusively on economists who are continually surprised by the economy. The Commerce Department's release of May data on retail spending surprised many economists by its weakness as noted by both the Post and the Times.

Economists who know economics were not surprised. Prior to the recession consumer spending was propelled by the $8 trillion in housing wealth created the bubble. This is the well-known housing wealth effect that economists were supposed to learn in their under-graduate training: annual consumption increases by 5-7 cents for every dollar of housing wealth. The bubble sent consumption soaring and pushed saving rates to record lows.

Now that most of the bubble wealth has disappeared, consumption is returning to more normal levels. Even now the savings rate , at around 4.0 percent, is well below its levels before the stock and housing bubbles, which averaged more than 8.0 percent. In fact, with most of the huge baby boom cohort in its 50s, with very little wealth accumulated for retirement, the demographics should be heavily tilted towards saving. This is why the small subgroup of economists who know economics are asking why consumption is so high, rather than so low.

Reporters should recognize that the economics profession doesn't have the same sort of internal controls as other occupations, like custodians or retail clerks, Therefore many economists are not good sources for information about the economy.

Comments (14)Add Comment
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written by skeptonomist, June 12, 2010 9:28
What authorities need now is another bubble, to boost the perception of wealth and increase spending. The finance industries will be glad to oblige - they are the allies of politicians who have to worry about the next election. All the economists who are beholden or sympathetic to those in power and finance industries will say that the new bubble is a good thing. The attempt to reinflate the housing bubble does not seem to have worked well, so the new bubble will probably be in another area.
The authorities include incumbent
politicians, the Fed, and other government economic and regulatory agencies who feel pressure or get increased scrutiny when the economy is bad. This is a very large and powerful group, and they have a lot of influence on economists and those who write on economic matters in the media.
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written by PeonInChief, June 12, 2010 9:28
Consumption is "high" because incomes have fallen and most people are spending most of their money on necessities, leaving little for savings. The bubbles hid the fact that the poorest 2/3 of the population really doesn't have the capacity to save much after paying the non-discretionary bills.
...
written by John Smith, June 12, 2010 10:43
PeonInChief: How many iPads did Apple sell in the first month? People are still out there buying crap they don't need in vast quantities! I'll give you my credit card when you take it from my cold, dead hands.
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written by izzatzo, June 12, 2010 11:49
Reporters should recognize that the economics profession doesn't have the same sort of internal controls as other occupations, like custodians or retail clerks, Therefore many economists are not good sources for information about the economy.


Exactly. Any custodian or retail clerk could have explained that wealth, not just income, drives consumption spending, where some economist would just babble that reduced consumption is obviously an adjustment under the Friedman Permanent Income Hypothesis.

Specifically, windfalls to highly variable income as that earned in the bubbles is saved rather than spent and vice versa in bad times, when savings is spent to maintain more stable levels of consumption.

All that consumption spending the custodians and clerks claim was due to wealth is just a myth. Didn't happen. No one ever lives in the short run wildly spending away a windfall. They only live in the long run, stashing away rapidly rising house asset value for retirement rather than current consumption.

That's why consumption fell, not because of a decline in wealth, instead, perfectly rational consumers are holding back on consumption in order to smooth out their long run permanent income with all thoses savings racked up during the bubbles.

Stupid liberals.
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written by EEYORE, June 12, 2010 12:10
"No one ever lives in the short run wildly spending away a windfall. They only live in the long run, stashing away rapidly rising house asset value for retirement rather than current consumption."izzatzo, June 12, 2010 10:49 am

Oh how nice. Sadly, I'd forgotten all about the rational consumer of EC101. Thank the Lord, s/he's back to save us all.
80 billion dollars for a upper-middle class AMT patch? Each year?
written by Rachel, June 12, 2010 8:21
I wonder if that's a factor skewing the excess spending data. (Maybe not. It seems unfair all the same.)
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written by Rex , June 14, 2010 11:54
Dean:
I think you are confusing two issues: One is the level of retail sales in May. The other is the level of consumption over a longer period, say a year or two.
It's perfectly consistent to have different views about those two subjects. You might think that consumption over the longer period will be somewhat weaker than normal because of the loss of wealth, the slow rise in labor income, and general uncertainty, AND also think that retail sales might have increased slightly in May (after all, retail sales had risen seven months in a row). There is no contradiction.
Having spoken to many of these economists who expressed "surprise" at May's drop in retail sales, I know that many of them also believe consumer spending will be somewhat tepid over the next year or two. The main source of their "surprise" was the large gap between what the automakers reported about their sales in May (up 4%) and what the government reported (down 1.7%). That has absolutely nothing to do with their views on the wealth effect.

Now, explain to us why consumption is so high...


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written by Robert Laing, June 15, 2010 5:31
Would Mr. Baker like to comment on the topic of strategic defaults? My understanding is that this policy on the part of homeowners is meshing with a banking sector policy of 'extend and pretend'. Money that would otherwise have gone to pay mortgages is going to consumption instead.
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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