Monday, August 29, 2011

Consumer spending after the crisis

The last post of SocialMacro, entitled A Quick Glance at the "Big Picture", touched upon the fact that the United States economy has not fully recovered to the trend level of output.  Further, employment as a percent of the population is far from what may be considered "full employment".  What has been experienced, instead, is a return to roughly the rate of growth before the crisis, but at a greatly reduced level of output and a fairly stable but far lower level of employment.  In short, the economy is still under-performing in the United States.

Economic output comes from four main sources, broadly.  Output comes from consumer spending, business investment, government spending (and investment), and net exports.  These different sources of potential spending should be examined individually to see the current problems and prospects for growth in the near future.  Investment is largely a function of output relative to its potential.  As long as expectations for the performance of the U.S. economy remains weak, investment will likely fall short of the socially desirable amount.  Where will the demand for the output of businesses be realized?  For now, it may be fruitful to examine what kind of growth will come from consumer spending.

The graph above represents real quarterly personal income over the last several years.  Real personal income began a decline in late 2008, after the collapse of Lehman brothers, and continued until late in 2009.  Since then the rate of growth appears to be similar to the growth trend preceding the crisis, but personal income remains depressed.  Unfortunately, the predictions of a "V-shaped" recovery have proven disastrously wrong.  There is some discussion among economists that economies generally recover much slower after a financial crisis than a "traditional" recession, especially those caused by an intentional contraction by a central bank, to stem a trend of increased inflation.  Whether that is true or not, there has not been a rapid "bounce back" to trend in output, employment or even consumer spending.

Paul Krugman and Gauti Eggertson have pointed out that one factor that is holding back the United States' economy from recovering is "debt deleveraging."  What this means is that during the years prior to the crisis, many households have gone deeply into debt and now they are trying to pay down their debt.  While in ordinary times, increased savings (or paying off debt), would be a good thing, it tends to depress the real demand for goods and services and is, consequently, counterproductive when the economy is operating well below its potential.

Having a higher savings rate could be good for an economy in full employment because it can mean a more rapid rise in potential output due to investments in the productive capacity of society.  In the current climate, it means that the economic impact of extra spending is dampened because for people are not spending as many cents per dollar as they did before the crisis, so it would take more dollars to get out of the same rut.

Looks like the private sector spending which prevails will not get the U.S. economy out of its current problems.  A full employment level of output will have to be achieved by other means (than cross your fingers and wait for it).  Policy intervention is the only reasonable alternative, but what options are available and what is likely to be done?

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