Consumer Spending in 1995: A More Difficult Year

Business Credit, July-August 1995 | Go to article overview

Consumer Spending in 1995: A More Difficult Year


Consumers' wallets staying put more often

In 1992, increased consumer spending accounted for almost 90 percent of all economic growth. By 1994, this share had shrunk to 57 percent, and this drop is expected to continue in 1995, to just over 50 percent. Since spending on retail goods and services accounts for about two-thirds of all economic activity in the United States, identifying individuals' spending habits is crucial to determining the remainder of the macroeconomic outlook.

Currently, consumers appear to be taking a break from the massive spending growth that was observed during the last half of 1994. There are many good reasons for this break, such as weaker employment growth, delayed income tax refunds and higher tax liabilities, higher prices on some key goods and a particularly mild winter, which reduced energy purchases.

Most of the month-to-month vagaries of consumer spending are difficult to identify since specific cause-and-effect relationships between spending factors and outcomes cannot be pinpointed. For example, retail sales fell in three of the first five months of 1994, but boomed in the latter half of the year. And so far in 1995, sales dropped in two of the first four months. So what's going to happen next? Even widely publicized consumer sentiment indexes don't help much in this regard. Most of these indexes are either concurrent or lagging indicators of spending, and these relationships are far from perfect.

Over the long haul, consumer spending will decline in importance as a contributor to the health of the economy. But this doesn't mean that a collapse of the retail sector is imminent. The consumer's relative contribution to total growth will shrink because other sectors, such as capital spending or exports, will be growing faster than total output. To put numbers behind the words, the volume of goods and services bought by Americans grew 3.5 percent in 1994. For the next three years, this growth will average just over 2.5 percent, while total real GDP growth will average 3.0-3.5 percent during the same period.

There are two ways that consumer spending trends can be examined: by looking at the underlying macroeconomic factors and by investigating specific spending components. An analysis of each set of factors yields the same conclusion: slightly slower growth in 1995. (Please note that the statistics in the next section describing macroeconomic indicators are in current dollars, while the data in the subsequent section are in inflation-adjusted dollars.)

Macroeconomic factors affecting consumer spending (in current dollars)

Compensation growth: neutral. Total compensation (which includes wages, salaries and benefits) of all individuals grew 5.9 percent in 1994. Similar increases are expected for the next three years, although the source of these increases will be different. In 1994, 3.5 million new jobs were added to the economy, expanding total employment by 2.6 percent. The outlook is for about 2.3 million jobs to be generated in 1995. However, because of the very tight labor market, particularly for skilled workers, wage increases will accelerate, offsetting much of the slower employment growth. Thus, in 1995, more of the benefits will go to those who are already employed.

Savings rate: slightly negative. The savings rate reached an all-time low in 1993 and 1994, with individuals saving a mere 4.1 percent of their income in each year. However, toward the end of 1994, the savings rate increased, strongly suggesting that consumers are adding an element of prudence to their spending habits. As a result, 1995's savings rate will be higher than 1994 at around 4.6 percent. By definition, income earned must be either spent or saved, so the share of income available for consumer spending will decline by half a percentage point.

Consumer debt growth: neutral. One of the most frequently quoted statistics is that the consumer debt-to-income ratio is at a cyclical high; therefore, consumers are too deep in debt and will be retrenching on their spending any day now. …

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