Yesterday on MSNBC there was a panel of all-purpose experts discussing the pressing issues, and one of them invoked the change to the American psyche caused by the financial crisis, and how everyone is returning to Depression-era thrift. Sorry, but I don’t see it, and neither do some economists. And today’s retail sales report suggests a recovery in spending as well, just a year after the crisis hit.
I don’t want to beat up on the MSNBC people too much: they mean well, and they’re as hungry for topics as any of us. (I also don’t want to insult people who have been out of work for a long time. It’s happened to me, and it’s awful to have to give up your lifestyle.) But I don’t see that the world’s largest economy would change its stripes after a few months of hard times.
Consider the long term record, illustrated in the graph below. The blue line is personal consumption expenditure, expressed in constant 2005 dollars, and the green line is the savings rate. There are two things to notice: one, that both have been in trends for many years, and two, that both briefly break their pattern around recessions. In the aggregate people spend less, and save more — for a little while.
Jared Franz, an economist at investment managers T. Rowe Price, was good enough to send me his thoughts on today’s retail sales report. For what the Commerce Department calls “retail control,” which is retail sales less purchases of cars, building materials and gasoline, and for the purposes of trend analysis is the core of spending, September was up 0.5 percent, after rising 0.7 percent in August.
“Retail control expanded at a 1.7% annual rate in Q3, and is likely to post at least as fast a growth rate in the current quarter,” he wrote. Well below past recoveries, but still an improvement.
“We’re getting back to levels of spending that are consistent with the pre-Lehman period,” Franz said in a phone call. For spending to really turn around, he estimates that the U.S. economy needs consistent job gains of about 40,000 per month, which he thinks we’ll see in first half 2010. His team also estimates that the savings rate might get back to its long-run average of five to six percent, but no more.
Economists at The Brookings Institution have thrown together a few econometric models of the crisis and possible recovery scenarios, and they too see no reason to expect permanent spending declines.
The authors, Australians Warwick McKibbin and Andrew Stoeckel, built a model that imposes a sharp drop in home prices, as well as a loss of confidence by both businesses and households.
The bursting of the housing bubble has a bigger effect on falling consumption and imports than does the reappraisal of risk, but the reappraisal of risk has the biggest effect on investment. Rising risk causes several effects. The cost of capital is now higher [that is, business owners expect higher returns] and leads to a contraction in the desired capital stock. Hence there is disinvestment by business and this can go on for several years - a deleveraging in the popular business media. The higher perception of risk by households causes them to discount future labor incomes and leads to higher savings and less consumption, fuelling the disinvestment process by business.
OK, that much we know already. But this study is helpful because it forecasts two different sorts of recoveries: one where there is no response by government, and housing prices and risk expectations don’t return to normal, and another where government steps in, and people and business see that policies are having a positive effect:
Under a permanent increase in risk premia [i.e. no government stimulus] there is a longer period of disinvestment, typically lasting the best of a decade before returning to baseline. But when agents unexpectedly switch and revise their expectations to a temporary scenario [due to a stimulus], investment recovers to baseline generally four years earlier.
So the economic models postulate that the results are all about government’s response, and how effective consumers and businesses think it’s going to be. That’s the important difference between The Great Depression and any recession since: at some level people understand that the government will step in, and that there’s insurance on bank accounts, and unemployment insurance. True, the recent crisis has been pretty scary, but in my view, there’s no reason to think that people will ignore the progress and revert to a Depression lifestyle if there’s no Great Depression.
