RebelCapitalist: Financial Information for the Rest of Us

Consumers Drive Our Economy.

Mar 18, 2009 | By: Mr_Blue | (0) Comments | Permalink | Tags: consumer spending, wages, disposable income

Consumers (we) drive the economy. This might not be surprising to most people. Consumer spending makes up 70% of our gross domestic product. But consumer spending has dropped tremendously over the past year. Economic growth and consumer spending are tied together. But this drop is not necessarily a bad thing in the long-term since we are carrying huge amounts of consumer debt and our personal savings rate as a nation is very low. Hopefully, one lesson that will be learned from this “Great Recession” is that our economy cannot continue to rely so heavily on consumers for economic growth without an increase in wages.

So what happened? Well, we overindulged - we were living beyond our means too long by taking on more debt. Check out this graph:

This graph shows the household debt service payments on consumer loans such as auto loans and mortgages as a percentage of disposable income (after tax income). Look at the steady climb in debt service payments as a percentage of disposable income and notice the cliff dive with around December 2007. The current recession official began in December 2007 (as determined by National Bureau of Economic Research). We were tapped out. We could not spend because we could not pay the debt. This cliff dive is probably because people were defaulting on mortgages and other consumer loans.

Now take a look at this graph:

The above graph is total personal consumption expenditures or consumer spending. The graphs look very similar. Could be because we financed our economic growth with debt? I think so.

There is a better way to finance consumer spending and that is with increase in wages which would result in higher disposable income. The growth in real wages (after consideration for inflation) has been stagnate over this period of time. This could mean that in order to maintain a certain standard of living we had to go more in to debt.

Source: Economic Policy Institute

In short term policy makers should focus on increasing employment. Hopefully, President Obama’s Recovery Plan will help a little. But in the long-term we have to decide how do we want to sustain economic growth in our country. I would argue it would be a strong middle class supported by a steady growth in wages.

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Consumers Drive Our Economy.

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