Will US consumers keep spending?

Some analysts predict that the US economy is heading into a recession. But if that is indeed the case, someone forgot to tell consumers. Although consumer confidence plummeted in August 2021 and has been falling ever since, putting it in the same territory as it was during the 2008 financial crisis, household spending is much higher than it was then.

When consumers speak to pollsters, they register a dour mood; but, whether shopping online or in person, they are still buying at an increasing pace. Second-quarter consumer spending is on track to have grown at more than a 4% annualized rate, which would make it among the best quarters in recent decades. The big question, then, is whether the spending boom will last.

After all, consumers have good reason to feel gloomy. Inflation is running at a 40-year high, and real (inflation-adjusted) wage growth is at a corresponding 40-year low. Real disposable personal income per capita fell for five straight months before leveling off in April, leaving it 2.1% below where it was in September. At the same time, consumer spending increased 2% since September, roughly twice its normal annualized rate.

How did consumers spend more while earning less? The answer is that they started to spend down savings. The personal saving rate fell from above average (with households accumulating assets) to below average as consumers dipped into their savings to smooth out their consumption over time.

Consumers should be able to keep this up for a while. Between March 2020 and December 2021, households received an additional $1.6 trillion in disposable personal income above and beyond the previous trend, owing mostly to government transfers like stimulus checks and unemployment insurance. At the same time, in response to the pandemic, consumers curtailed their consumption by $800 billion relative to what would have been expected. That means consumers entered 2022 with $2.4 trillion in excess savings; and that figure doesn’t even account for the huge run-up in asset markets through the end of 2021.

These extra savings show up directly in the form of higher balances in checking accounts, which are regularly reported by the JPMorgan Chase Institute. But checking-account balances are only the tip of the iceberg, reflecting about one-tenth of the excess savings. Households also used their pandemic windfalls to repay debt (resulting in lower credit-card balances) and to accumulate other assets.

All told, the past four months of below-average savings represent only about a $100 billion reduction in households’ additional reserves, leaving another $2.3 trillion. That is a lot of fuel for consumers to be able to spend. And, again, if asset markets were counted, the number would be even higher, because the market declines in 2022 have yet to come close to offsetting the huge increases over the previous two years.

But just because consumers can increase their spending does not necessarily mean that they will. Any predictions about future consumer behavior must be viewed with caution. Normally, consumer spending is closely linked to the growth of real disposable income, which is represented as a flow. Yet over the last three years, consumer spending has largely been determined by a combination of attitudes toward COVID-19 and the desire to keep spending on a smooth path.

Remember, after spending fell by much more than it needed to for purely budgetary reasons in 2020 (as consumers avoided face-to-face services), it then failed to increase by as much as would have been expected from the extraordinary income growth in 2021. Consumers thus were able to avoid cutting back amid the recent rapid declines in income. It is anyone’s guess whether this smoothing behavior will continue; but I expect that it will, at least by enough to keep consumer spending growing at a roughly 2% annualized rate in the second half of the year.

Consumer spending represents about two-thirds of the US economy. If it stays strong, that will prevent overall growth from turning negative and the economy from slipping into recession. Most of the postwar recessions were preceded by at least one quarter of slow consumption growth – with consumer spending slowing further or even turning negative during the recession itself.

Moreover, other elements of the economy are also pushing against recession. For example, fixed investment is increasing, because businesses still have access to relatively cheap capital with which to rebuild their lean inventories.

Advertisement The sharp rise in mortgage interest rates this year, however, should curtail residential investment. And since the US is still importing a lot of its consumption, high oil prices and global supply-chain issues will remain a concern. Many financial signals are flashing red, including a stock market nearing bear territory and a yield curve that is almost inverted (long-term interest rates are nearly lower than short-term interest rates, signaling investor concerns about the future). Anything could happen in the coming months, and next year will be even more difficult to navigate if the US Federal Reserve keeps raising rates in the face of persistent inflation.

Unfortunately, even if real consumer spending slows, it would not necessarily be enough to bring down inflation. Real spending growth could slow dramatically even while nominal spending continues to rise rapidly if prices and wages are both growing robustly in nominal terms. A slowdown or even a recession would likely put downward pressure on inflation, but not necessarily by more than a half or full percentage point. That means bringing inflation down may prove even more difficult than keeping growth up.

Project Syndicate, 2022