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January 11, 2011
The pluses and minuses of reluctant consumers
If you've been keeping up with news from last weekend's convergence of economists at the annual meeting of the Allied Social Science Associations, you will probably have heard of this optimistic-sounding conclusion by Harvard economist Martin Feldstein:
"It is not hard to imagine that a few years from now the current account imbalances of the US and China will be very much smaller than they are today or even totally gone."
An advance copy of the article was provided a few weeks ago at Real Time Economics, and considerable commentary has followed since (here, here, here, and here, for example). Not surprisingly, the progress Professor Feldstein envisions has two components:
"The persistence of large current account imbalances reflects government policies that alter the savings-investment balances in both the United States and China.
"The large current account deficit of the United States reflects the combination of large budget deficits (negative government saving) and very low household saving rates. ...
"In contrast, China's large current account surplus reflects the world’s highest saving rate at some 45 percent of GDP [gross domestic product]."
The source of Feldstein's belief that progress will come?
"Consider first the situation in the United States. Current conditions suggest that national saving as a percentage of GDP will rise as private saving increases and government dissaving declines. Private saving has been on a rising path from less than two percent of disposable income in 2007 to nearly six percent of disposable income in 2010. The forces that caused the rise in the U.S. saving rate since 2007 could cause the saving rate to continue to rise. Those forces include reduced real wealth, increased debt ratios, and a reduced availability of credit. ...
"The reduction of the U.S. current account deficit implies that the current account surplus of the rest of the world must also decrease. While this need not mean a lower current account surplus in China, I believe that the policies that the Chinese have outlined for their new five year plan are likely to have that effect. These include raising the share of household income in GDP, requiring state owned enterprises to increase their dividends, and increasing government spending on consumption services like health care, education and housing."
Some skepticism about the probability of a substantial decline in Chinese saving rates was noted in a recent post at The Curious Capitalist, which focuses on some interesting new research that relates high Chinese saving rates to an increase in income volatility. To the extent that the increased income volatility is inherent in China's ongoing transition to a more market-based economy, substantial changes in consumer behavior might be difficult to engineer. That said, only about half of the increase in Chinese saving rates appears explainable based on natural economic forces, and the Chinese government can certainly reduce national saving of its own accord (via deficit spending). Furthermore, according to Feldstein's calculations, a relatively small decline in the Chinese saving rate could eliminate their side of the current account imbalance.
As to the first part of the equation—an increase in saving by U.S. consumers—Atlanta Fed President Dennis Lockhart offered this yesterday in remarks prepared for the Atlanta Rotary Club:
"Households have been actively deleveraging—that is, working down debt levels and saving more of their income. The savings rate has increased from a little over 1 percent in 2005 to more than 5 percent currently.
"Consumer debt as a percent of disposable income has declined markedly over the past three years after rising steadily since the 1980s. Most nonmortgage consumer debt reduction has been in credit card balances. As consumers have reduced their debt, the share of income used to service financial obligations has fallen sharply to the lowest level in a decade.
"Consumer action to reduce debt is not the whole deleveraging story. In the numbers, the decline in overall household indebtedness has been highly affected by bank write-offs. Also, banks' stricter underwriting requirements for new consumer debt have contributed to runoff.
"I expect the phenomenon of household deleveraging to continue."
Restrained consumer spending was one item on a list of three "headwinds" that President Lockhart believes will serve to restrain growth in 2011 (the other two being policy uncertainties and ongoing credit market repair). Not that this is all bad:
"First, today's headwinds to a significant degree reflect structural adjustments that will, in the longer term, place the U.S. economy on a stronger footing. The preconditions for strong future growth are reduced uncertainty, improved consumer and household finances, and healthy credit markets.
"Second, I believe the headwinds I have emphasized will restrain growth but not stop it. I fully expect growth in gross domestic product, in personal incomes, and in jobs to be better in 2011 than in 2010.
"Finally, I acknowledge the potential that economic performance this year could surprise me on the upside. Businesses, for example, are sitting on lots of cash. Cash accumulation is not something that can continue forever, particularly in the case of public companies. It may not take much weakening of headwinds to unleash some of the economic forces that thus far have been bottled up."
Though faster progress would be welcome—particularly with respect to job creation—the Lockhart and Feldstein commentary makes it clear there is a delicate balance between resolving the short-run pain and setting up the longer-term gain.
By Dave Altig
Senior vice president and research director at the Atlanta Fed
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January 04, 2011
Looking back, looking forward
Kicking off the new year, the latest edition of the Atlanta Fed's EconSouth magazinecontains our annual review of the year past and our bravest guess about the one to come (articles in this issue include outlooks for the national, international and Southeast economies and features on small business and other topics). If we are looking for enduring lessons about the national economy from the previous year, I nominate the time-tested but oft-ignored advice to be wary of reading too much into short-term economic ups and downs:
"Better-than-expected increases in several economic indicators in the spring led many economists to revise up their growth estimates. A quick snap-back in the economy, as has been typical in most other deep recessions in the post–World War II era, seemed a distinct possibility.
"However, such a snap-back was not to be. It is now clear that some of the rebound in growth stemmed from a rebuilding of depleted inventories in the first quarter and the waning influence of various government spending programs. By summer, the incoming economic data had weakened considerably, and the pace of expansion in the major expenditure categories raised the specter of a step backward into contraction…
"Bumpy growth for an economy transitioning out of a recession is not unusual. For example, GDP [gross domestic product] jumped by 3.5 percent in the quarter immediately following the end of the 2001 recession, but it then slowed to just 0.1 percent three quarters later. To date, that pattern of growth proceeding in fits and starts has certainly been representative of this recovery."
In fact, it now appears that the U.S. economy grew in 2010 by somewhere in the range of 2.5 percent to 3 percent, just where the Blue Chip consensus was at the beginning of the year (and, incidentally, somewhat better than what we at the Atlanta Fed were expecting). Still…
"Despite these improvements, economic performance has been somewhat disappointing. The recovery has not been strong enough to meaningfully reduce the unemployment rate. Throughout the year, the unemployment rate has remained well above 9 percent. Income growth (excluding transfer payments made by the government) has been weak—up less than 1 percent for the year on an inflation-adjusted basis. The housing market is struggling in the face of continuing foreclosures despite a variety of tax incentives and historically low mortgage rates, and the commercial real estate sector likewise has not recovered. This theme of improvement in some areas and ongoing weakness in others illustrates the unevenness of the recovery and more uncertainty than normal about future economic prospects."
Will 2011 be a different story? Quantitatively, probably yes—growth should take another step up this year. But the story, we think, remains essentially the same:
"The incoming data as well as reports from the Atlanta Fed's business contacts are broadly consistent with a relatively restrained growth trajectory. There are, in fact, several factors that will plausibly inhibit the pace of the expansion. Weakness in residential and commercial real estate is ongoing. Business and consumer attitudes are still extremely cautious, and slow spending growth by businesses and households is continuing to hold back inflation. Over the near term, additional business spending appears likely to be geared primarily toward activities such as targeted mergers and acquisition and further increases in efficiency rather than toward pure expansion. Slow and uneven sales, opportunities to reduce costs through increased productivity, structural adjustments in labor markets, and uncertainty over government policy—including changes in labor and environmental rules, tax policy, and financial regulations—are restraining job creation. Slow job growth, naturally, implies that unemployment could remain elevated for some time."
"Of course, risks lurk on both the upside and downside for the outlook, but there are reasons for optimism. Financial firms and households have made significant headway in repairing their severely compromised balance sheets, and most are in a much better financial position than they were a year-ago. Businesses in particular have substantially more liquidity and significant capacity to deploy capital to new projects. Some of the uncertainties that have vexed private decision makers, such as the course of near-term tax policy, may finally be abating…
"Recent surprises in the economic indicators have been predominantly to the upside, which is a very good sign. If such positive surprises persist, and confidence in the economic environment grows, it could be that current estimates for only slight improvement in 2011 have been too modest."
Note: For more perspective on the 2010 economic outlook and monetary policy, stay tuned for Atlanta Fed President Dennis Lockhart's speech to the Rotary Club of Atlanta, scheduled for Monday, January 10. The text will be posted on the Bank's website.
By Dave Altig
Senior vice president and research director at the Atlanta Fed
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