Are Consumers Holding the Keys to a Better Economy?

Overall consumer spending still accounts for about 70% of gross domestic product, but some government statistics suggest that consumers may have reduced spending drastically in recent years, especially on purchases that are not considered absolutely necessary.¹

According to a report from the Federal Reserve Bank of New York, discretionary service spending (which excludes basic needs such as housing, food, and health care) dropped almost 7% since the beginning of the most recent downturn and has yet to recover significantly. Going back many decades, this category of spending had not fallen more than 3% per capita during past recessions.²

The employment situation, historically high household debt, and a general lack of confidence may be affecting the average consumer’s ability and willingness to spend — a trend that could continue to weigh down economic growth.

Lost Buying Power

High unemployment and several years of slow wage growth mean that many consumers simply have less money to spend. Midway through 2011 and one year into the economic recovery, national average wage levels were nearly the same as they were at the beginning of 2008.³

High gas prices in the first half of 2011 also ate into disposable incomes and forced many consumers to forego discretionary purchases such as furniture, vacations, and restaurant meals.⁴

A Thin Debt Cushion

In the past, consumers have often added debt, even during lean times, so they could continue to spend. But debt levels have risen to such a point that many American households may not be in a position to rely on borrowing.

The household debt-to-income ratio (after taxes) peaked at 135% in the third quarter of 2007 and fell to 119% by mid 2011. By comparison, it averaged only 89% in the 1990s. Highly leveraged consumers who must devote a larger portion of their incomes to paying off debt may have little choice but to limit spending on other goods and services.⁵

Shaken Confidence

Even consumers who have not faced job losses or other types of financial difficulties may have seen their net worth and/or confidence damaged by housing price declines, global financial crises, and general economic and market uncertainty. It’s possible that a lingering lack of consumer confidence is one of the reasons why many people have been slow to return to their old shopping habits.

Consumer spending usually falls during an economic downturn. Generally, this is followed by the emergence of pent-up demand and a rise in consumer spending, which is normally a significant driver of growth during recoveries.⁶ However, it’s unclear how long it will take for hard-hit consumers to regain the financial strength and confidence to resume spending — or how much more consumption may be needed to help propel the economy forward.

1, 4) The New York Times, June 27, 2011
2) The New York Times, July 16, 2011
3) CNNMoney, July 27, 2011
5) The Wall Street Journal, July 15, 2011
6) The New York Times, July 19, 2011

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