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Personal Income up $38 Billion in April: Personal Savings Go Deeper into Negative Territory, Fed Risks a Recession

Prof. Peter Morici - 6/30/2006

Today, the Commerce Department reported in May personal income increased $38.3 billion or 0.4 percent, disposable personal income increased $31.6 billion or 0.3 percent, and personal consumption expenditures increased $40.3 billion or 0.4 percent. The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This index increased 0.2 percent in May and was up 2.1 percent from May 2005. This was same situation as in April. Clearly, inflation has Ben Bernanke worried to the point that he is willing to risk recession to contain it.

Significantly, personal outlays exceeded disposable income by $162.9 billion in May, and the savings picture got more worrisome. In April, personal outlays exceeded disposable income by $153.5 billion. The savings rate—personal savings as a percentage of personal disposable income—declined from minus 1.5 and 1.6 percent in March and April, respectively, to minus 1.7 percent in May.

Although consumers continue to spend, gasoline and imported petroleum are taking a bigger bite. In May, retail sales less gasoline purchases declined, and Ford, GM and Chrysler are likely to report another disappointing month in June. The combination of bigger payments for imported petroleum and foreign brands capturing more of the U.S. auto market significantly reduces the demand for U.S. made goods and services from steel to software.

Also, higher mortgage rates are slowing the housing market, and higher credit card rates should soon moderate consumer spending. No one should be surprised that despite strong profits business investment is erratic, and corporations are using profits to buy back shares rather than rapidly expand their U.S.-based enterprises.

Overall, rising petroleum prices, the flagging competitiveness of U.S. automakers and Fed interest rate hikes are slowing the economy, albeit with more of a lag than expected.

With the savings rate so low, it would not take much of a further upward movement in interest rates, especially housing mortgage costs and terms, to cause a radical adjustment in consumer behavior. An abrupt one or two percent point positive adjustment in the savings rate could easy turn the economic slowdown into a recession.

The expected moderation in U.S. growth will shave less than one percentage point off the rate of growth in global consumption of petroleum and other resources. International oil and resource markets will continue to instigate inflationary pressures, and these can be little affected by Fed policy. If it chooses to raise interest rates further, the Fed will do little to curb inflation but risks throwing the economy into recession and stagflation.

Now is the time to quit raising interest rates. Sometimes the best monetary policy is to do no harm.