Income and Spending Decline: Is the Recovery Neglecting Main Street?

Both consumer spending and personal income were weak in April, according to data released by the U.S. Bureau of Economic Analysis on Friday. The data, which fell short of analyst expectations, suggests that while consumer confidence is at post-recession highs, economic conditions have not yet totally caught up.

Personal income decreased by $5.6 billion in April, or less than 0.1 percent, while disposable personal income decreased by $16.1 billion, or 0.1 percent. Personal consumption expenditures — the U.S. Federal Reserve’s preferred measure of inflation — decreased $20.5 billion, or 0.2 percent. Analysts were expecting personal income to increase 0.1 percent, spending to remain flat, and the personal consumption index to decline just 0.2 percent.

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At a glance, this points to two things: one, the consumer sector is losing some steam; two, the U.S. Federal Reserve has plenty of room left for monetary easing.

Personal Income and Outlays

Source: U.S. Bureau of Economic Analysis

“Consumer price inflation has been low,” commented Chairman of the Fed Ben Bernanke in a testimony before Congress this month. “The price index for personal consumption expenditures rose only 1 percent over the 12 months ending in March, down from about 2-1/4 percent during the previous 12 months. This slow rate of inflation partly reflects recent declines in consumer energy prices, but price inflation for other consumer goods and services has also been subdued.”

The latest data from April confirms Bernanke’s position: if anything, inflation is too low. The Fed currently holds a medium-term inflation target of 2.0 percent with an upper limit of 2.5 percent. It’s clear, given the data, that inflationary pressure remains weak.

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U.S. Inflation Indicators

Source: U.S. Bureau of Economic Analysis

One of the reasons why inflation remains so low could be because of downward pressure from contractionary fiscal policy. As Eric Rosengren, president and CEO of the Federal Reserve Bank of Boston pointed out in a speech earlier in May, “when we total up the cuts in state and local government spending and employment, the cuts in federal government spending and employment, and recent tax policy, we actually see that U.S. fiscal policy has been quite contractionary for several years now – beginning well before the recent payroll tax increase and the reductions in fiscal spending mandated by the federal sequester.”

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“Contractionary fiscal policy will in the near term place downward pressure on inflation and upward pressure on unemployment,” he added. Rosengren goes on to argue that given the still-high headline unemployment rate (7.5 percent) and below-target inflation (approximately 1.0 percent), monetary policy may not actually be accomodative enough.

Inflation3

Source: Federal Reserve Bank of Boston

If fiscal austerity is the path chosen by Congress to achieve long-term economic growth — through a balanced budget and reducing the deficit — then monetary policy has to be considerably accomodative to offset the headwinds caused by that contractionary policy. “At least part of this ‘miss’ on inflation and employment outcomes can be attributed to the emergence of more fiscal restraint than might have been expected,” Rosengren commented.

He continued: “I would argue that the ‘miss’ on outcomes is not evidence of monetary policy ineffectiveness. In fact, in the sectors of the economy that are likely to be most responsive to lower interest rates, like housing and consumer durables, recent growth has been quite rapid. Contrary to the notion that policy has not succeeded, I would actually say that monetary policy has been quite effective in offsetting the contractionary effects of recent fiscal policies.”

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However, where the recovery has not been very evident is in the labor market and in personal income. April’s data showed that personal income declined marginally, while real disposable income declined 0.1 percent. The BEA also showed that the personal savings rate remained flat at 2.5 percent, up from 2.1 percent at the beginning of the year, but below its average over the past few years, and well below what many economists argue is necessary.

Chart2

Source: U.S. Bureau of Economic Analysis

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