Economist's Commentary: February 29, 2008

Consumer Spending Views: Greenspan versus Bernanke

By Lawrence Yun, Chief Economist

Today's report from the Commerce Department on personal consumption for January showed a monthly gain of 0.4 percent. But that increase was all driven by rising prices on the products purchased (i.e., the PCE deflator also rose 0.4 percent). The same was the case in the prior month with consumption and prices rising by an equal 0.3 percent. In other words, consumer spending has stalled. There is no increase in real consumer spending.

With consumers accounting for nearly 70 percent of the economy, a halt in spending will drastically hold back economic growth. GDP growth in the first quarter of this year, hence, will be very weak if not negative as a result. But what are the prospects of consumer spending going forward?

The current Fed Chairman Ben Bernanke has said that the economy is likely to avoid a formal recession if there is a pickup in economic growth in the second half. This premise is partly based on a solid rise in salary and wages over the past year. After all, U.S. workers received a total of $6.4 trillion in salary and wages in 2007, an increase of $342 billion from the prior year. Furthermore, a recent fiscal stimulus package could add up to $150 billion in extra spending money. Bernanke is implying that paychecks and tax rebates will do the trick in kick starting consumer spending and helping us avoid recession.

Meanwhile, Alan Greenspan has recently spoken of a greater chance of recession than not. His views are based on the importance of consumer spending, not out of paychecks, but from asset value accumulation. In particular, the only economic research paper he authored while at the Fed was on the consumer spending impact from changing housing values. NAR, at his request, collected survey data after closings regarding what people do with their capital gains after selling their home. The data supported his views that consumer spending is importantly influenced by home value changes.

With home values falling in many parts of the country, Mr. Greenspan believes that paychecks will not be enough to offset the impact of decline in home values. Research estimates vary, but most place housing equity impact at around 7 to 10 cents for each dollar change in housing value. In other words, if home values rise by $1,000 then consumers feel wealthy and go out and spend about $70 to $100 on average. The inverse would apply when home values fall. (The stock market wealth effect is generally smaller - placed at around 3 to 5 cents). Given that home values have fallen - in some markets - by measurable amounts, Mr. Greenspan is betting that consumers will retrench as a result. With consumer spending falling, then that will likely tip the whole economy into a recession.

My views on the matter are that both paychecks and housing values are certainly important and they carry different weight at different times. But even if consumer spending continually stalls or even turns mildly negative, we will likely avoid an economic recession because of other factors. Corporate profits - outside of the financials (subprime losses) and homebuilding - are quite good. At over $1.5 trillion, profits have doubled over the past 5 years. Therefore, business spending growth will be respectable. In addition, exports are booming thanks to a weaker dollar. It is not just consumer spending that directs the overall economy. Though smaller in impact, business spending and exports will save the economy in 2008. My forecast is for 2 percent GDP growth in 2008 - not healthy, but not a recession either.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.