Will U.S. GDP Benefit From February’s Spending and Income Gains?

Source: Thinkstock

Source: Thinkstock

Consumer spending in the United States has been growing at a modest pace, and in February, Americans spending increased by the most in three months. Data contained in the Department of Commerce’s Personal Income and Outlays report showed that personal consumption — which includes spending on products ranging from shoes to fuel oil — rose 0.3 percent last month. That slight gain follows January’s even smaller 0.2-percent rise, which itself was more modest than expected; Friday’s report downwardly revised January’s gain from 0.4 percent. While the size February’s consumer spending increase does suggest that the cold weather that plagued much of the country early this year has loosened its frigid grip on the U.S. economy, spending is overall still quite soft.

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“The momentum is shifting higher,” TD Securities deputy head of U.S. research and strategy, Millan Mulraine, told Bloomberg. “It’s moving in the right direction, though we are starting from a lower base than otherwise would have been thought.” The cold weather has not only put consumer spending at a low starting point for 2014, but also made it difficult for economists to understand underlying consumer spending trends.

Almost as important as the overall consumer spending figure is what sectors of the economy drove household expenditures. In January, medical expenses accounted for more than half of the months spending increase, likely because a number of Americans were paying premiums for policies purchased through the Affordable Care Act’s insurance marketplaces. Those insurance policies went into effect on January 1. “Those people who are now covered by Medicaid for the first time or who have recently signed up for a private policy have started to consume medical services,” Capital Economics economist Paul Dales said in a note to clients, obtained by The Wall Street Journal. 

In February, services accounted for that majority of the overall spending increase, rising 0.3 percent, while spending on goods rose just 0.1 percent. Again, Americans’ increased spending on services was likely driven by increased for health care services and utilities, like heat.

Strong consumer spending is essential for the recovery of the American economy. Consumer spending accounts for approximately 70 percent of gross domestic product in the United States, and because government and business spending largely remained remained weak in 2013, the economy depended even more on household purchases to fuel growth. For economists, the all-important question is where the consumer spending trajectory is headed this year. Overall, consumer spending accelerated in the final six months of last year; in the fourth-quarter, consumer spending — uninspired by any meaningful increase in income — rose 3.3 percent, offsetting a 12.8 percent decrease in government spending and pushing annual GDP growth to 2.6 percent for the period. That increase was the largest quarterly gain recorded since the closing three months of 2010.

But spending did slow at the turn of the year, prompting speculation as to whether cold weather was the sole culprit for the downturn. The slowdown was significant enough for Barclays analysts to lower their forecast for first-quarter GDP growth from 2.4 percent to 2 percent. Still, encouraging signs for the economy have popped up in recent economic reports. The Commerce Department’s retail sales figure showed a similar reality as Friday’s personal incomes and outlays data; for the first time in three months retail sales increased on a month-over-month basis, rather than decreasing, posting a 0.3 percent gain. Furthermore, U.S. employers added 175,000 jobs to payrolls last month, economists — and the American public — were given evidence that the economy may not be creating jobs at pre-recession levels but “inroads” into unemployment are being made. However, continued improvements in the labor market and gains in wages are needed to sustain higher consumer spending levels; rising stocks and home values only help a certain sector of the American population.

Incomes did rise last month, meaning consumers had more funds to cover their purchases; there is only so much spending that consumers can finance from savings. After adjusting for inflation, disposable income — or money left over after taxes — rose 0.3 percent, matching January’s increase. Wages and salaries jumped 0.2 percent after rising 0.3 percent the previous month.

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Wages increases are running far below their pre-crisis levels. As Paul Krugman noted in a March 12 opinion piece for The New York Times, even though the latest jobs report reported that wages had accelerated in February, that gain was due to what is called snow jobs. Citing a report from Goldman Sachs, Krugman explained that average hourly wages normally spike after a spell of cold weather because the workers idled by bad weather tend to be hourly workers, who are paid less than salaried workers. That means that average worker in snowy months tends to be better educated and better paid than in normal months, and the jump in measured wages is a statistical artifact, not a sign of tight labor markets. The fact remains that wage increases remain small. But while Congress, President Barack Obama, and economists argue over whether minimum wage should be lifted, more jobs, higher home prices and strong equity returns have given consumers more money to spend, with household wealth rising by $2.95 trillion in the fourth-quarter to a record $80.7 trillion, according to data from the Federal Reserve.

The Commerce Department’s personal spending metric, along with the complementary savings measurement, are very indicative of the health of the U.S. economy. For personal finance, the old adage goes: it is not what you make, but what you keep. However, while that may be sound advice, often what is good for the individual — meaning saving — may not be so good for the economy. The savings rate was 4.3 percent in February, up from 4.2 percent the previous month. At that level, Americans are saving just about as much as they did in the run-up to the financial crisis. Between 2005 and 2007, the annual rate averaged 3 percent, after rising as high as 11 percent during President Ronald Reagan’s first presidential term.

Economists believe that pent-up demand for consumers, whose typical spending patterns were derailed by the cold weather, will jumpstart economic growth this year. But the fact that a measure of overall inflation slipped in February suggests that consumer demand is still rather weak. Along with maximum employment, price stability is one of the Federal Reserve’s dual mandates, and policy makers, who have been expecting pricing pressures to pick, will likely be concerned about the low inflation rates. After showing some signs of stabilization, the price index for personal consumption expenditures, the Fed’s preferred gauge of inflation, rose a seasonally adjusted 0.1 percent in February, on a month-over-month basis, and 0.9 percent on a year-over-year basis.

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Fed officials have already indicated they are concerned over the low inflation rate. Following last week’s meeting of the Free Open Market Committee — which is charged with overseeing the nation’s open market operations — Chair Janet Yellen said policy makers “are fully committed to the 2 percent inflation objective, and we do not want to undershoot inflation for a prolonged period of time.” Meanwhile, Federal Reserve Bank of Atlanta President Dennis Lockhart said Tuesday that persistently low inflation “could very well be indicative of some more fundamental weakness in the economy.”

Early last year, it became clear that American consumers were keeping their purchases limited to immediate necessities as confidence in the economy, and the economy’s ability to created enough jobs to fill the gap left by the recession, remained weak. Later in the year, better employment gains, combined with growing household wealth from the stock market rally and improving real estate values, put a significant number of higher income Americans in the position to increase their outlays. But while the overall picture of consumer spending has been one of improvement, a closer view reveals more conflicting indicators about the health of the American consumer, especially along socioeconomic lines.

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