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January 25, 2002

Is the Well of Consumer Spending Going Dry?

Is it patriotic to spend money? Thank goodness economists don't have to answer questions like this. But just about every other consequence of spending dollars comes under our purview, which brings us back to much the same question. Is it good for the economy for consumers to spend money?

That direct, simple question turns out to be anything but simple to answer. But in grappling with the complexity of how spending affects the economy, we also come face to face with some of the challenges the U.S. economy faces today as we try to reverse our downward slide. Spending by consumers translates into income for businesses and workers, which those with empty order books and unused capacity desperately need. But dollars which are spent are not saved, and savings form the pool of funds that make productivity-enhancing investment possible.

When it comes to spending money, American consumers have no peer. Our appetite for spending over the last five years has pushed savings rates -- defined as the fraction of income set aside each period -- down to levels once thought to be impossible. For the calendar year 2000, we spent an average of 98.8 cents of every dollar we earned. But on numerous occasions, including as recently as October of last year, egged on by zero percent interest rates on car loans, the savings rate has actually dipped below 1 percent.

That's less than a penny saved for every dollar earned. By comparison, saving rates in Europe are between 8 and 15 percent, whereas in Japan the rates range between 20 and 30 percent. There are some technical issues that make a direct comparison of these savings rates inappropriate, but on the big question there is simply no doubt. We don't save nearly as much of our incomes as other industrialized nations do.

But we've actually used that deficiency to our advantage in recent years. Thanks to a torrent of capital from abroad, we've managed to have our cake and eat it too, at least for a time. The U.S. economy has been such a good place for foreigners to invest that companies have had adequate access to capital even as domestic consumers went on a long spending binge. The result was a rate of economic expansion that was the envy of the world.

As we look out our windows in year 2002, the world economy is a changed place, and we would be wise to note the differences. Nine months of employment cutbacks andproduction declines have reduced consumers' aggregate capacity to spend, and have dimmed the boundless optimism of our recent past. And the continued turbulence in stock markets is evidence that U.S. equity markets aren't absorbing as much international capital as they once were.

That same combination of events has also pushed some consumers into a financial corner. The sharp increase in personal bankruptcies in 2001 is only the most visible sign of a course correction in household spending patterns that is occurring at all income levels. As occurs in every economic downturn, this causes savings rates to go up, and for consumption to contract slightly more than income changes alone would dictate.

Thus when it comes to consumer spending, the economy walks a tightrope of sorts. In the throes of a recession, the mass tightening of belts can bring on what economists call the "paradox of thrift," with prudent individual spending decisions producing a painful collective result. Too much spending, however, threatens the supply of funds for investment that keep the economy productive and competitive. Is it any wonder why economic policymakers have so many gray hairs?

Link to this commentary: https://commentaries.cberdata.org/439/is-the-well-of-consumer-spending-going-dry

Tags: finance, economics


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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