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Consumers Continue to Hold Up the Economy

Prof. Peter Morici - 12/29/2006

The Commerce Department reported in November personal income increased $33.8 billion or 0.3 percent, disposable personal income increased $27.0 billion or 0.3 percent, and personal consumption expenditures increased $50.5 billion or 0.5 percent.

On an inflation adjusted basis, personal consumption expenditures were up 0.5 percent in both October and November. This is much better than in third quarter, and consumers continue to hold up the economy.

Overall, the economy is executing a soft landing. If consumers keep spending at the pace established in October and November, growth in the range of 2.5 percent in 2007 is achievable.

Inflation and Federal Reserve Policy

The price index for personal consumption expenditures, including food and energy, was unchanged in November, and was up 1.9 percent from November 2005.

The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This core price index was unchanged in November, after rising 0.2 percent in September and October. In November, the index was up 2.2 percent from November 2005.

As important to the Federal Reserve, the market-based core inflation index, which excludes food, energy and imputed prices like rent on owner occupied homes, was unchanged in November. That index has increased 1.9 percent since November 2005.

Core consumer price inflation is beginning to fall within Ben Bernanke’s target range of one to two percent. However, a few months of favorable news on core inflation are not enough to declare victory in the fight on inflation. More good news will be needed to convince the Federal Reserve that inflation is corralled.

Moderate economic growth and falling housing prices should relieve pressures on inflation; however, oil and gasoline prices have begun rising again. Hence, the Federal Reserve’s outlook for inflation remains guarded.

Chairman Ben Bernanke will want to make sure inflation is safely contained before stimulating the economy, even if that means risking a recession.

Savings and the Stock Market

The savings picture deteriorated. Americans continued to spend more than they earned. In November the savings rate was minus 1.0 percent, as compared to minus 0.7 in September and October.

With housing prices falling, savings should improve in 2007. Purchasing a larger home than a family needs is no longer a good speculative investment, and Americans are likely to spend less on new homes and invest more in the stock market.

Coupled with moderate growth, falling housing prices and more savings should help the stock market regain its footing. The stock market rally should resume in the New Year.