Americans Did Not Really 'Cut Spending for First Time in 20 Months'

What matters is how much stuff people purchased -- which was virtually unchanged from May to June

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Today, Yahoo's homepage featured the grim Associated Press headline "Americans cut spending for first time in 20 months." I'm not one to flinch at bringing to light bad news about the economy, but in the sense that really matters, AP's assertion isn't that meaningful. Although nominal spending may have declined for the first time in 20 months, real spending -- adjusted for inflation -- was virtually flat, after having already declined over the prior two months.

Here's a chart that shows the change in real personal consumption expenditures from the Bureau of Economic Analysis:

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As you can see from the chart, real spending actually fell back in April -- when the recovery began to show some clear signs of deterioration. Since then spending has continued to decline. But in June, it was actually the closest it's been in three months to growing again. It was -0.03%. That rounds to being approximately flat. This isn't great, but it also isn't as bad as the contraction we saw in April or May -- and it certainly doesn't warrant a splashy negative headline.

Why look at real spending instead of nominal spending? Real spending better shows how much actual stuff (goods and services) Americans purchased. Think about it: what's a worse sign, if you spend $25 less than you did last month (but buy the same amount of stuff) or if you buy less stuff than you did last month (but spend more actual dollars doing so)? The latter would indicate a clear effort to cut consumption, while the former could merely be a result of declining prices. The first scenario is exactly what happened in June: inflation dropped so Americans spent less money to purchase approximately the same amount of stuff that they bought in May. Firms didn't see materially fewer sales, and Americans didn't consume less.

So Americans did not cut spending for the first time in 20 months in June in the sense speaks to why we care about spending. Consumption was virtually flat. In fact, the AP missed its opportunity for a provocative headline in April. At that time they could have said: "Americans cut consumption for the first time in 16 months." Indeed, that was an alarming trend, which appears to be ending. So now isn't the right time to alarm the public.

In the article AP also considered incomes without taking inflation into account. It says that incomes rose by just 0.1%, the weakest growth since September. Again, however, if you take inflation into account, then real income rose by 0.3%, which is the most since February. And real disposable income increased by just over 0.3%, the most since May 2010! Here as well, how prices move matters a lot: income is relevant insofar as it shows consumers' purchasing power. That can only be understood if prices are considered. In May Americans' purchasing power rose by the most it has in more than a year.

I don't mean to be too hard on AP -- I used to perform the same superficial analysis of this economic report without paying close attention to the effect of inflation, until I realized that the BEA provides inflation-adjusted figures. But even if AP's analysis isn't performed on a deeper level, the organization should take care not to portray a lukewarm economic report as a dire one that could crush the sentiment of millions of Americans who click through Yahoo's homepage.