Consumer Spending ECO 2301 Principles of Macroeconomics Anthony Le November 30th, 2011 Consumer Spending Consumer spending is defined as “the goods and services bought by the households in the satisfaction of their wants and needs. ” (BusinessDictionary. com). It is also known as personal consumption expenditure and is the largest part of aggregate demand or effective demand at the macroeconomic level. Why is consumer spending important in the U. S. economy? In fact, consumer spending is the single biggest determinant of the U. S. conomy’s health, accounting for about two-thirds of the United States’ annual Gross Domestic Product (GDP). A decline in consumer spending could spoil the U. S. economy or certain market sectors. By paying close attention to the economic reports that track consumer behavior, one may be able to distinguish significant changes in spending habits and adjust their portfolios accordingly. The purpose of this paper is to examine different aspects that could affect the consumer spending, determining whether consumer spending could drive a recovery in the economy, and knowing when and how to get the consumers to spend again.
Perhaps, at the end, we as the consumers could really help drive this economy out of its slump by understanding consumer behavior and adjusting our spending habits suitably. Everyday, consumers make decisions about goods and services we purchase. There are several factors that affect these decisions. Some of these are prices, choices, needs, etc…Apart from these; there are also others that change consumer spending. One such factor is the level of their income.
As the expectations of future income and employment decrease, the level of consumer spending also decreases and the level of saving starts to increase. The willingness of people to make major spending commitments depends on how confident they are about both their own financial circumstances, and also the general state of the economy. Research shows that in June of 2011, U. S, consumer spending unexpectedly dropped for the first time in almost two years due to the slump in hiring. It is one factor that hurts the household confidence. “Purchases declined 0. 2 percent after a 0. 1 percent gain the prior month. (Chandra) Moreover, the effect of wage gains that have failed to keep pace with the inflation combined with the lack of jobs together raise the risk of further cuts in consumer spending, which account for 70 percent of the world’s largest economy. The dropping prices of stock and the increase in price of gas make the situation even worse for those who are facing luster wage growth in this phase. Some of the numbers are – “S&P 500 Index fell over 2. 6 percent in August to 1,254. 05; and as the Treasury security rose, the yield on the 10-year note was sent down to 2. 61 percent from 2. 5 percent in the same month. ” (Chandra) In the contrary, the Americans boosted their savings rate to 5. 4 percent, the highest since last year from 5 percent. This shows the slump in consumer confidence could threaten to derail any recovery. Also wages are so sluggish that they are affect ting consumer spending and confidence as well. Weekly earnings had dropped 0. 9 percent in the 12 months ended in June on average (figures from the Labor Department). Furthermore, the labor market is still struggling to heal. The jobless rate rose up to 9. 2 percent in June while payrolls grew up by 18,000, the fewest in 9 months. Chandra) In addition, the economy had failed to create more jobs to fill up the unemployment gap; thus, reducing consumer purchasing power. Another factor also affects the level of confidence in consumer spending is fuel costs. It has been said that higher expenses for necessities such as energy are also limiting purchasing power. The cost of regular gasoline rose in May to about a three-year high of $4 per gallon, and remained $3. 70 at the end of July, according to AAA auto group. Higher gasoline prices are causing many Americans to dig deeper into their wallets to pay for the cost of commuting, shopping trips, and vacations.
This leaves less money to pay for discretionary purchases that help fuel economic growth. It is estimated that every $1 increase in the price of gasoline translates into an additional cost of $1,000 a year for most drivers. As a result, low income households began to feel pressures from higher energy bills, which already affected negatively discounted retailers. Long term, the pain at the pump could become more widespread. A survey released in April by the Financial Services Forum, an association of the CEOs of 20 large U. S. financial institutions, reported its members’ view escalating energy prices as the biggest threat to U.
S. economic growth, ahead of rising health-care costs and terrorism. The rise in gasoline also caused the fall in auto sales. Cars and light trucks were sold at an average 11. 41 annual rate in June, the slowest in a year. (Chandra) Besides household incomes, high fuel cost and energy prices, interest rate is another key factor that determines consumer spending in the economy. Interest rate hikes have already reduced demand for mortgage refinancing and home-equity loans, two significant sources of cash that increased consumer spending in recent years.
As interest rate rose, consumers most likely found it less desirable and less reasonable to borrow against the equity in their homes. As a result, they tend to put off buying luxury goods for their home, such as TVs, entertainment systems, or other goods. With the above aspects, we as consumers are still uncertain whether we will show up and spend again. With the expectation of dropping high fuel prices and interest rates as well as increasing in wages, we will more likely to have our confidence in purchasing goods and services. Until then, Federal Chairman Ben S.
Bernanke said in his semi-annual testimony to Congress on July 13 that “There is also ongoing uncertainty about the durability of the recovery”. Knowing the factors that could affect consumer spending, the next question that one can ask is whether consumer spending could drive a recovery in the economy. The first question we need to ask ourselves is what really is considered ‘spending’? Are households paying down debt and rebuilding their nest eggs considered ‘spending’? Not quite exactly! But, that still can boost up the economic improvement in some ways. Consumers nowadays are still struggling with debts.
Due to cheap financing, lax lending standards, and a surge in wealth from home values and stock prices, consumers are still carrying the debts that have been taken on over the past decades. With the subsequent reversal of fortune and wealth losses, households are forced to divert more income away from spending and toward savings and paying down their debt. As a result, their efforts to pay off some of the debts and rebuild savings limit the recovery’s strength. So far in this decade, households’ debt-to-income ratio has risen twice as fast as it did in the 1990s. Although the optimal level is yet still unknown, but if he ratio had grown along the slower trend of the 1990s, it would be about 110 percent now. And that would imply households have some $2. 2 trillion in excessive debt they would need to eliminate. (Cooper) So, back to the question whether consumer spending could really drive a recovery in the economy, the answer can be optimistic, given that consumer spending has stabilized this year despite the ongoing realignment in household finances. However, the majority will also depend on the labor markets. The slower the labor markets heal, the more drawn out the process will be, and the fewer consumers will be able to contribute to the recovery.
Next, let’s take a look at how to get consumers spending again. Hypothetically, if consumers make more money in their pockets and confidence that their paychecks will keep coming bi-weekly or monthly, then chances are they will start to spend on purchases. However, that might not be so easy. What really gets consumers spending depends on the retailers and how they are able to get customers to open their wallets. Getting consumer spending, which is behind more than two-thirds of the U. S. economy, moving again is considered a key to a strong economic recovery.
But “Households aren’t in the mood”, said Paul Dales, U. S. economist for Capital Economics. The key is the retailers must be able to deliver “shoppability” to the customers. It is the ability to translate consumer needs and desires into purchases. The most important things for retailers are relevance – making sure products consumers want are in stock and at fair prices. And they have to know their customers and their unique needs or demands. (Deprez) Meanwhile, experts say shoppers will most likely not return to free-spending ways until they have more confidence in the future and stable cash in their paychecks.
Several ways to increase consumer purchasing power – reducing tax burdens, falling unemployment claims, improved real wages, and firming home prices. Besides those, factors such as extending unemployment benefits, expanding job-training efforts, or strengthen the dollar also help boost up the consumer spending again. (Anderson) As the economy slowly shows signs of recovery, we can see that there is clearly a wealth effect that takes place in the households. As Americans feel wealthier, they are more willing to spend more. In the previous years, housing market stabilizing helped consumer spending climb 0. percent in August of 2009 after a revised 0. 1 percent increase in May. The rise was boosted by spending on nondurable goods, which were up by 1. 7 percent in June. Also, for housing market, evidences showed that the condition were stabilizing with U. S pending home sales advanced about 3. 6% in June. Another positive sign for U. S. consumer is the efforts by the federal government to increase spending. The “cash-for-clunkers” program, which came into effect in 2009, was a big factor in boosting auto sales for Ford Motor. Their reported total sales rose up to 2 percent for July of the same year and still increased in almost two years. Steverman) So now we can see that when it comes to the economy, the numbers are gradually improving. But, the fear of the Americans losing their jobs is still there. It seems that when the good numbers in our economy are increasing, the employment will not pick up anytime soon. Hence, we are usually worried about our job prospects; thus, will have decided that we should be saving more because there is no forecast of real improvement in the job market anytime soon. After all, in the article “Consumer spending, wages, cooled in August”, Kowalski and Willis have shown us the overall look into the U.
S economy in recent time of the year. While purchases rose 0. 2 percent after a 0. 7 percent increase in August, 2011, earning decreased 0. 1 percent, according to Commerce Department figures on September 30th in Washington. At the same time, retailers such as Best Buy Co. and Target Corp. might have suffered from little hiring, stagnant wages and a plunge in stocks that have shaken confidence in the recovery. Employment rate held above 9. 1 percent, and the average hourly earnings fell for the first time in more than three years, further stressing consumers’ incomes. Moreover, stocks market tumbled.
The S&P 500 Index in September was heading toward its fifth monthly lost, the longest falling streak since March 2008. (Kowalski & Willis) As a consumer, I understand the important of knowing about the factors that drive consumer spending and how it affects our economy. I realize not only do our consumers spending contribute to the recovery of the economy, but also the businesses that play a big role in helping the people have stable income. Hence, it gives consumers the confidence in purchasing the goods and services that satisfies the needs in our everyday life. References Chandra, Shobhana. U. S. Consumer Spending Unexpectedly Falls as Hiring Slumps. ” Businessweek 02 August, 2011: accessed 28 November, 2011. < http://www. businessweek. com/news/2011-08-02/u-s-consumer-spending-unexpectedly-falls-as-hiring-slumps. html> Cooper, James C. “Business Outlook: Why Consumer Spending Won’t Drive a Recovery. ” Businessweek 18 June, 2009: accessed 28 November, 2011. <http://www. businessweek. com/print/magazine/content/09_26/b4137014208931. htm> Deprez, Esme E. “Retail Sales: How to Get Consumers Spending Again. ” Businessweek 13 August, 2009: accessed 28 November, 2011. lt;http://www. businessweek. com/bwdaily/dnflash/content/aug2009/db20090813_136087. htm> Steverman, Ben. “When Will Consumers Start Spending Again? ” Businessweek 04 August, 2009: accessed 28 November, 2011. <http://www. businessweek. com/bwdaily/dnflash/content/aug2009/db20090813_136087. htm> Kowalski, Alex & Willis Bob. “Consumer Spending, Wages, Cooled in August” Businessweek 30 September, 2011: accessed 28 November, 2011 < http://www. bloomberg. com/news/2011-09-30/consumer-spending-in-u-s-slowed-in-august-as-incomes-unexpectedly-dropped. html>