First and foremost, income drives consumer spending; that’s why the Commerce Department’s Bureau of Economic Analysis monthly release of income receives so much attention. Today’s release [3] showed that income increased 0.3 percent and the gains in January and February were revised upward (January’s report initially showed a 1.0 percent leap and is now estimated to have increased by 1.2 percent, and December’s gain was revised from 0.4 percent to 0.5 percent -- we’ll talk more about revisions to several economic series later in the week). Recall that January’s outsized gain was driven largely by the lower tax withholdings called for by the Middle Class Tax Relief Act of 2010 (I certainly noticed a difference in my paycheck, and my local restaurants and bakeries were the primary beneficiaries).
Before partially answering the question of what drives consumer spending, another point to note from today’s release is the large increase in energy prices – not a surprise to anyone who pays attention to gasoline prices, but an unpleasant fact of life nonetheless. As we wrote earlier in the month [4], when gasoline prices go up, people respond, on average by spending more rather than buying less gas (well, they do buy less gas, but only by a small amount, as the demand for gas is pretty inelastic in the short run).
Going back to consumer spending. Another factor in consumers’ spending decisions is how wealthy they are (where “wealth” is sometimes referred to as household wealth or household net worth). When consumers become wealthier, their spending goes up. This relationship has long been studied, but just how much consumer spending changes when wealth changes is still up for debate. (Estimating the precise relationship between wealth and spending has proven difficult for a number of reasons – lack of good data being one of the primary culprits. Additionally, disagreements arise over the underlying economics that explain the estimated empirical relationships between wealth and spending.) Despite the debate, the pretty chart below shows a nice relationship (or at least a correlation) between consumer spending and wealth.
[5]
During the recent recession, household net worth got walloped by a double whammy: falling home prices that reduced housing equity and a drop in stock prices, and the chart above shows just how much wealth plummeted. More recently, household net worth in the fourth quarter of 2010 (the latest available figure) stood at $56.8 trillion, an increase of 5.9 percent over the past year (these data come from the Federal Reserve [6], Table B.100). This increase was primarily driven by financial assets, which is based on stock prices.
Recent increases in wealth should boost consumer spending throughout 2011. And with the S&P 500 averaging a 7 percent gain in 2011 over its average during the last quarter of 2010, consumer wealth looks likely to increase further. Why is the stock market up, especially given the tumultuous events in North Africa, the Middle East, and Japan? Good question. I’d like to think it’s because folks have developed a more positive outlook on the U.S. economy, and indeed economic forecasts for growth in the U.S. have been revised upward since November of last year (again, the tax cuts played a big role in this). The latest Blue Chip forecast also anticipates solid quarterly gains in consumer spending (in the realm of 2.8 to 3.2 percent at an annual rate, adjusted for price changes) in each quarter of 2011.
~Mark Doms, Chief Economist, U.S. Department of Commerce
March 28, 2011
