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On the Record

Retail Sales and Consumer Spending an Important Part of the Economy

Retail sales for April rose 0.5% according to new government numbers, but while the trend has been positive over the last 10 months, it suggests a continued modest pace of economic expansion overall—and one slower than past post-recession rebounds. Karen Dynan discusses the latest retail sales figures, noting that consumer spending makes up 2/3 of the U.S. economy.

Retail Sales and Consumer Spending an Important Part of the Economy
Today’s retail sales report was fairly consistent with what we have been seeing for some time now, which is that consumer spending is growing, but it is not growing at a particularly impressive pace (particularly by the standards of past recoveries). We are seeing some hints that the increase in gasoline prices is eating into family budgets because we are seeing a lot of the growth coming from spending at gas stations, and the spending on other sorts of items is actually growing much more slowly, and more slowly than it has been growing.

Consumer spending is an important part of the economy. Solid growth in consumer spending is an essential ingredient of our robust and self-sustaining recovery. This is partly because consumers historically account for two-thirds of spending. Of course it is not the only ingredient to a successful recovery. For example, we need to see jobs continue to grow because we need those jobs in order for income to continue to grow. People need that income to be able to spend.

How does commodity pricing affect consumer spending?
Commodity prices have been rising quite rapidly over the past year or so since last summer, and that is slowing spending in this country. The most prominent example would be the price of oil. The price of oil (notwithstanding some decline in the last couple of weeks) is up 30 percent from where it was a year ago. That has translated into much higher gasoline prices, and that means that families need to commit a larger share of their spending to filling up their gas tanks, which means they have less money left over to spend on other goods. That is, essentially, a reduction in their real income which is slowing the economy.

The Recovery: slow and moderate
We are looking at a pretty slow recovery. We have seen periods over the last year and a half when the economy has looked like it was picking up, and people would start talking about the economy gaining a head of steam. We have seen other periods where the economy has slowed down, and people have worried about it stalling and there being a double-dip. I think that fact is that it keeps averaging out to a slow, moderate pace of expansion. I think that is what we will continue to see.

So what can we do about that? First of all we need to be patient. There are still important structural problems in our economy that need to be worked through. We went into the recession with an oversupply of housing, with a fragile financial system, and with too much debt. Things have improved on some of those margins, but we have more to work off.

I think the government needs to be focused on creating conditions whereby businesses feel comfortable planning ahead and hiring. So, for example, they need to work out a plan for reducing the deficit and the debt over the long run so that businesses have the confidence to move forward with their plans. They need to make sure that we don’t have excessive regulations that are holding businesses back from hiring. To the extent that we use any fiscal policy to support the recovery, at this point it should probably be fairly narrowly targeted on creating jobs. For example, the reduction in payroll taxes this year – that is letting businesses hire more cheaply (effectively) because they can put the same amount of money into workers’ pockets at a lower wage. So that is encouraging hiring.

I think another thing they might think about is whether there are cost-effective ways to match some of the workers that have been unemployed with new jobs. We have a very high rate of long-term unemployment in this recovery. In fact it is higher than it has been at any time, even in the worst episodes we have seen in the post-war period. I think we should be exploring whether there are cost-effective ways to retrain workers, or to match them with employers.

Saving, spending and borrowing: their impact on the recovery
We need to see higher saving and less borrowing than we saw during the boom. Saving has already come up. The savings rate has been running between five and six percent. So it is up from a low of one percent during the height of the boom. That is partly because households need to replenish the wealth that they lost when house prices fell and stock prices fell. It is partly because houses have come to the realization that they cannot count on rapid growth in house prices, and stock prices to essentially do the saving for them. So I think we are seeing higher saving rates and we are going to need those savings rates to remain higher. That is going to slow the recovery, but in the long-run it is going to put households in a more solid and sustainable position; so it is going to be more conducive to long-term growth.

I think the other issue is borrowing and deleveraging. Households went into the crisis with very large amounts of debt – very high commitments to make monthly payments on debt – and that left them extremely vulnerable. We have seen household debt fall a lot. Part of that has reflected people defaulting on their debt and shedding their debt that way; but part of it has been a reduced pace of new borrowing which reflects (to some extent) a greater prudence on the part of consumers that they are less comfortable borrowing. It also reflects financial institutions being less willing to lend to households. However it is happening, this slower growth in debt is, again, something that is leading to the slow recovery in consumer spending, but it is also something that is going to be good for households over the longer run because it puts them in a stronger financial position.

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