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.
Just for mgoodfel, here's a chart of personal saving, based on data from the Bureau of Economic Analysis. Again, we're most interested in the time period since Q3 of last year to present. Even though it dipped in Q3 2009, it's still 55% above the Q3 2008 level: