Explaining the Discrepancy

There is clear evidence that many consumers are cutting back on spending, either involuntarily or by choice. All you have to do, for instance, is look at the damage that has been done to the bottom -- and top -- lines of companies in industries that are dependent on discretionary spending (e.g., tourism and casual dining) to see that habits have changed from what they were, say, two years ago.

Yet as I noted last month in "More Dependent on the Consumer than Ever," the share of U.S. output accounted for by personal consumption is not far off its record highs. That is despite the fact that the savings rate has ticked up from the ridiculous low levels that were seen when euphoria was running rampant.

As it happens, The Atlantic Business Channel offers up an interesting explanation for the apparent discrepancy in "How Are Consumers Spending So Much?":

Could consumers be spending more than they should be? Such a possibility would go against an often heard complaint by economists that Americans aren't spending enough and consequently exacerbating the recession. This is the basis for the so-called "paradox of thrift," which says that when people save during a recession, it makes matters worse because their lack of spending hurts the economy. While I understand that logic, I've railed against the idea that consumers should be spending more, because they just don't have the money to responsibly spend more. University of Chicago economist Casey B. Mulligan presents a fascinating chart that implies that the common complaint I've noted might be misguided.

Here's that chart, from his blog post today on the New York Times Economix blog:

And here's Mulligan's explanation of how to read it:

Each series is displayed as an index, with its value at the start of the recession (December 2007) set to 100. Consumer spending normally trends up more than employment does, so I have adjusted for that by removing prior trends from consumer spending and work hours.

For example, a value of 95 for real consumer spending in September 2009 means that inflation-adjusted consumer spending in September 2009 was 5 percent below what it would have been had it continued its previous trend since December 2007.

This chart suggests that, although aggregate work hours (labor) are plummeting relative to the trend, spending hasn't followed over the past year. Since the fall of Lehman last year, Mulligan notes that spending has fallen by 2% on his chart, while labor has fallen by 10%. He concludes:

While it is conceivable that a few percentage points' decline in consumption could cause a many-fold reduction in work hours, it seems more likely that the reduced consumer spending was mainly a reaction to layoffs and hours cuts. The roots of this recession go a lot deeper than the paradox of thrift.

I think that's right. And it also raises a question: what's going on here? Reports show that personal saving is up. Also, labor is down. How hasn't spending followed -- where are consumers getting the money to continue to spend?

One potential explanation is credit: maybe consumers are borrowing in order to spend more than their labor implies they have. But everything we've been reading indicates that banks aren't lending as much. I constructed this chart below from Federal Reserve data on consumer credit outstanding, which supports the assertion that consumer credit has decreased in the past year:

All measures of credit have declined, but I find the blue line most notable. It represents revolving credit, like credit cards. That would be most responsible for everyday spending through credit. It's decreased by nearly 8% from September 2008 to August 2009.

A more plausible explanation is that unemployment benefits have bridged the gap. Frankly, I can't think of any other possibility. If credit is down and saving is up, something must be keeping spending going.

Since spending is precisely what unemployment benefits are for, I don't think it's quite right to say that spending is greater than it should be. I'd take away a different lesson. This suggests that as more unemployment benefits expire, the U.S. could face a situation where spending plummets further, and the economy finds it even harder to recover. This would be a sort of vicious cycle caused by prolonged unemployment.

Comments

[Jim]

I don't know where the numbers on consumption come from... but it is clear that they are wrong.

If you look at state sales tax reporting you will see that most have fallen between 15% to 25% -even though many have actually raised the tax rate. I suspect sales tax reporting is a fairly accurate indication of consumption and falls in line with labor numbers in the article.

Bottom line: I suspect, like most other areas, "Explaining the Discrepancy" is simply a matter of realizing that, if provided by government, we are usually working with tainted numbers.

[GreenAB]

i would another possible reason:

income distribution.

unfortunately i can´t find the article stating that a small percentage of people (high income/net worth) are responsible for a giant percentage of consumer spending.

since the upper class wasn´t hit that hard by the crisis but even got bailed out they might not cut back spending that much.

[carol]

Jim, I also thought about the sales tax receipts discrepancy. However, the number you mention 15 - 25% down, is for all of the states income: state income tax (if applicable), cap. gains (losses), and sales tax.
I recall state sales taxes being down 8 - 15%.

So still a significant discrepancy. Could it be explained by sales tax exempt necessities consumption?

GreenAB also has a point. The top 1% 'earns' 25% of total yearly income in the US. Wealth distribution is even more extreme. A trader from Citygroup in a note to clients some years ago
had analysed the US and UK as "plutonomies" in order to help investors select stocks (investors should invest in companies selling luxury goods to rich people, such as Louis Vuitton). Just google plutocracy and it explains to a large extent Michael's graph.

[Ken]

The sales tax discrepancy could be caused by retailers lying when they report and forward the sales taxes they have collected. In other words, if sales are $100,000 for the period, a retailer may claim only $80,000 and keep the tax collected on the other $20,000. When business is bad this is a huge temptation.

[Mark Stevens]

The first chart shows a change in the trend, not a change in the actual consumption, so there
is no sales tax discrepancy. I think the article might be on to something. Note that consumers
confidence has recently gone down even though the media is screaming that the recovery is
here. If people are looking at an end to their unemployment checks in the near future then their
consumption going forward may well drop further (i.e. Christmas sales). Also note from the second
chart that even though outstanding revolving credit has been reduced the total amount is about what
it was in the summer of 2007 when people were still maxed out before the peak of the market
in Oct 2007. I think people who can afford to not use their credit cards are cutting back, but those
that have no choice are still maxing them out.

[Karen]

Maybe instead of paying their mortgages, people are spending that money as disposable income now.

[HSpencer]

I am afraid the dismal Christmas sales will further deplete many companies staying power. I agree with Mark. Many people are desperate now, and know the January 2010 unemployment will skyrocket. Retail is trying everything possible, price cuts so deep it is shocking. I bought $450.00 (retail) worth of clothes at a store the other day for $55.20. Of course the mark up is reflected in that $450.00 but the discounts and 75% offs are much deeper than noted earlier. The items retail wants to move for Christmas have already taken a deep discount on line, and also in stores. ie: Xbox360, Laptops, Cameras, etc. Retail will fail badly if they have to count this stock on the Jan 10 inventory. Retail, already known for the axe in January, will chop off until there is hardly anyone to open the door and turn on the lights. I know of one retail small chain that is working one person for only 4 hours and then the other 4 hour person comes on, and the final one closes up. It is really sad, because retail will die on the vine in '10 or '11 at the latest. There are many other things I could say about retail, but won't air them here!!!!

[wageless]

House Extends Jobless Benefits:

http://www.nytimes.com/2009/11/06/us/politics/06benefits.html

A lifeline for consumer spending...

[Mia]

Sadly the benefits extension is leaving out a lot of people. For example - March was by far the worst month for cuts (and once the BLS makes the annual adjustment it's literally going to be almost a million cut that month) - and those who began drawing UI in March will not finish their extended EUC until January. I know someone whose benefits expire the second week in January who is devastated that they fall outside the window for the 20 week extension because they do not expect hiring to pick up (professional jobs don't get hired that time of year - all the hiring managers are on vacation, and next year's budget won't be done til Feb 1). Congress really should have changed that Dec. 31 cutoff date.

[Natalia]

Some believe that spending money comes from borrowing from 401ks and insurance policies.

[GreenAB]

addition: B.White (lpl financial) this morning on cnbc: "the top 20% earners are responsible for 2/3rds of spending"

[Regular Reader]

my theory is that so many people are not paying mortgages, thus essentially living rent-free prior to eviction, that their cumulative redirection of former mortgage payments into current consumer purchases accounts for the current situation