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Economic Forecasts

Slower Consumer Spending Gains Ahead

Consumers' purchases account for nearly 70% of the nation's GDP, so as their spending goes, so goes the economy.

Consumer spending has held up better than expected in the face of higher gasoline prices early this year, but there are signals of a slowdown. That could slacken economic activity and ultimately change the pace at which companies hire more workers.

SEE ALSO: Economic Issues That Will Drive the 2012 Election

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Personal consumption expenditures, the broadest measure of consumer spending, rose 2.2% in 2011 and climbed at a 2.9% annual rate in the first quarter of this year, as Americans rushed to buy new automobiles, even when gasoline prices threatened to top $4 a gallon nationally.

The increase in consumer spending, however, came mainly from families that escaped the recession in relatively good shape, according to studies by Karen Dynan, co-director of the Brookings Institution's economics program. Households hit by layoffs, the tight job market and heavy debt burdens are still hanging back.

Even the surge in automobile buying stemmed largely from pent-up demand, not broad economic strength, says Dynan. Cars bought before the recession were getting old and costly to operate. Surging gasoline prices propelled consumers into springing for more fuel-efficient cars. And the economy seemed to be picking up, encouraging those with the wherewithal to buy to take the plunge.

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More recently, consumer spending has slowed, despite a decline in pump prices. Last week's Commerce Department report, for example, shows consumers turning cautious. Retail sales rose a scant 0.1% in April, following stronger gains in February and March. Gains in personal consumption expenditures ebbed to 0.1% in March, down from 0.5% in February, after adjustment for inflation.

What's more, the savings rate has been declining, suggesting that households are dipping into their nest eggs to finance their outlays. Wages haven't kept pace with inflation or with increased borrowing. "There's a pretty serious risk here that households are stretched thin," Dynan points out.

In fact, consumer credit soared by 10.25% in March -- the sharpest rise since late 2001. And America's personal savings rate has hovered around 3.8% this year, well below the 5% to 10% rates that prevailed during the 2007-2009 recession.

Other factors also suggest that households won't be going on any binges soon. The job market remains weak. Export growth is waning. The fallout from millions of mortgages in or near foreclosure will continue to weigh on the housing market. Stock prices are falling.

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Moreover, there remain serious risks to the still-fragile recovery. Financial markets may suffer from a collapse of the euro; China's economy may slump; Congress may fail to fix the nation's spending and tax problems, taking more money out of the economy. Dynan, for one, believes that many households are so overextended that they "aren't in a position to withstand another body blow to the economy."

In the short run, the increased consumer borrowing and low savings rate may be a good omen, suggesting that households will boost their spending over the next few months. Certainly the lower prices at the pump should provide a modest upward bump in the near term, propelling the economy a little faster.

But the statistics also signal underlying stress, heralding a cutback in household outlays. Once the economy is back on track, consumers spending less and saving more will be good news. But for now, it's not the course to keep the economy growing.

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