Economist: ‘Tepid’ consumer spending may slow recovery

Editor’s note: This is the second of four reports related to The City Wire’s The Compass Report. The Compass Report, presented by Benefit Bank, is the first comprehensive quarterly analysis of the Fort Smith Regional Economy. The Consumer Compass Report will be released Wednesday (Dec. 1), and third-quarter 2010 The Compass Report will be released Thursday (Dec. 2). Link here for the first article in the series.

The national economy will see continued GDP gains in future quarters, but employment nationwide and in Arkansas is not likely to improve, according to economist Jeff Collins.

Collins, economist for The Compass Report and former director of the Center for Business and Economic Research at the University of Arkansas, said another unknown is the level of the all-important consumer spending.

“The over-riding concern is the frail nature of the recovery led by tepid consumer demand. Consumers remain committed to reducing debt rather than returning to past consumption patterns,” Collins said in the national economic review portion of The Compass Report.

Following is Collins’ view of national economic factors and trends.
• GDP GROWTH
Advance estimates for third quarter GDP indicate the economy continues to grow, although below trend, at an annualized rate of 2%. Indications of a return to growth are concentrated in the output data as employment growth remains elusive. For the fifth straight quarter, GDP was positive. The revised final estimate of second quarter GDP was 1.7%. This was a slight upward revision from an earlier estimate of 1.6 percent. The data, although not as robust as hoped for by policymakers, indicates it is highly unlikely the economy will slip back into recession.

• EMPLOYMENT ISSUES
That said, employment remains the paramount concern for forecasters who predict little improvement in U.S. labor markets is likely over the next 12 to 18 months. The national unemployment rate stood at a seasonally adjusted 9.6% in September, roughly 0.5% below the high from September of 2009.

While the unemployment rate provides a lagging indicator of labor market performance, job gains provide a better measure of future direction of the economy. In September, the economy lost an estimated 95,000 non-farm jobs. Based on data from the U.S. Bureau of Labor Statistics, the economy shed an estimated 393,000 jobs from June to September. This followed five months of consecutive job growth. No doubt poor employment data posed a significant challenge for incumbents in the recent mid-term elections.

Continued growth in output will eventually require firms to hire. The question remains, when and how quickly will the private sector add jobs? Obviously, companies continue to do more with less having made significant investments in software and equipment during the recession.

• CONSUMER SPENDING
The over-riding concern is the frail nature of the recovery led by tepid consumer demand. Consumers remain committed to reducing debt rather than returning to past consumption patterns. According to a recent report on consumer debt levels by the New York Federal Reserve Bank, U.S. consumers have shed roughly $1 trillion in debt since the third quarter of 2008.

“Consumer debt is declining but only part of the reduction is attributable to defaults and charge-offs,” said Donghoon Lee, senior economist in the Research and Statistics Group at the New York Fed. “Americans are borrowing less and paying off more debt than in the recent past. This change, which we continue to study carefully, can be a result of both tightening credit standards and voluntary changes in saving behavior.”

Personal consumption expenditures comprise two-thirds of all economic activity.

According to the U.S. Bureau of Economic Analysis, monthly data indicates improvement since the third quarter of 2009. Real personal consumption expenditures increased 1.9% in the third quarter, compared with an increase of 1.7% in the second quarter. Disaggregating the data, durable goods increased 5.1%, compared with an increase of 8.4% in the second quarter and nondurable goods increased 2.7%, compared with an increase of 2.6%. Finally, services increased 0.4%, compared with an increase of 0.2% in the second quarter.

• STOCK MARKETS
Despite the anemic rate of recovery, the markets have performed relatively well. For example, the Dow Jones Industrial Average peaked for the year on Nov. 5 at roughly 11,444. The markets, despite the lack of clear direction in the economic data, have exhibited remarkable growth.  Recently, European sovereign debt issues coupled with FOMC plans to purchase long-term treasuries have negatively impacted investor confidence.

It is highly unlikely the federal government will attempt to stimulate additional growth through fiscal policy. What is likely is the Federal Reserve will continue to use monetary policy to add stimulus to the economy, at least to the point that inflation becomes a real concern. This implies the recovery is increasingly in the hands of U.S. companies and most importantly U.S. households.

• FED MOVES
Finally, despite concerns from a variety of Fed watchers. monetary policy remains decidedly expansionary.

Per a November press release of the Federal Open Market Committee (“FOMC”) of the Federal Reserve, the Committee remains concerned by high unemployment, modest income growth, lower housing wealth, and tight credit coupled with weak investment in nonresidential structures, flat housing starts, and lack of employment growth. The result was an announcement by the Committee that it intends to increase its holdings of long-term Treasuries by $600 billion by second quarter of 2011, increasing the money supply significantly.

Of real concern is how Fed actions will exacerbate the devaluation of the dollar against other major currencies. Many observers wonder if devaluation isn’t part of a broader strategy to turn the balance of trade and invigorate the recovery with export led growth.