Are Consumers Really Down for the Count?

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THE STASH NOVEMBER 18, 2009

Are Consumers Really Down for the Count?

The worst pullback in consumer spending since the 1970's has apparently come to an end, as the following chart shows:

Since August this data point has reentered positive territory -- a fairly good indicator that a recession is over. Still, the major worry out there is that the end of the home-as-ATM era means people will have fewer funds to spend. This in turn would imply that a return to the long-run-average of 3.5% annual growth in spending is a long shot.

But a new study by the Boston Fed's Daniel Cooper suggests that we shouldn't be overly concerned with the impact of declining home-equity extraction on spending. Cooper argues that only the credit-constrained (that's economist shorthand for those with little access to credit) borrowed heavily against their homes to consume. He estimates that an 11% decline in housing wealth in 2008 lead to only a 0.75% fall in non-housing-related spending. In other words, declining home prices could only have a small impact on people's willingness to spend. The basic reason is that, in a given year, the majority of homeowners are not credit constrained, so a big drop in home prices shouldn't affect their spending ability (that is, if you believe Cooper and Willem Buiter's contention that the housing wealth effect is really the housing-as collateral effect).

Sure, there are other reasons why Americans might be more cautious about spending going forward: Say, a post-crisis change in the consumption culture or the impact of high credit card debt levels. On the other hand, a better-than-expected job market, which isn't out of the question, might put many worries to rest.

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posted in: the stash, economy, boston, boston fed, daniel cooper, willem buiter, iin

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