Government spending has helped make up for falling wages. The key question now: Can consumers hang on long enough for business to come around, too?
As consumers go, so goes the economy. Over the past couple of decades, their spending patterns have accounted for more than 70% of the ups and downs in yearly economic growth. So it's natural to assume that as the job market goes, so go consumers. However, that's not always true, especially right now. Even amid massive job losses in the first quarter, household demand shows every sign of stabilizing. After dropping at a 4.1% annual rate in the second half of last year, real consumer spending appears to have grown about 1% last quarter. Weak retail sales in March, which may have been depressed by this year's late Easter on Apr. 12, followed solid gains in January and February, especially excluding autos.
The key question is: Will this stabilization continue? If it does, businesses will quickly eliminate their excess inventories and feel less need to slash output and payrolls. If it doesn't, companies will keep cutting back, prolonging the recession.
The signs are hopeful. Right now, the labor markets, which account for 60% of household earnings, are not the only influence on consumer spending. Income from wages and salaries is down 0.2% from a year ago, after yearly growth of 3.5% this time last year and 5.7% two years ago. However, the other 40% of income is up about 9% from last year, and that pace is set to pick up through midyear.
Much of that strength reflects government support from so-called automatic stabilizers, such as unemployment insurance, which ramp up payments to households as times get harder. Total government payouts to consumers are up 12% from a year ago, including an extra-large 5.8% annual cost-of-living adjustment for Social Security recipients, reflecting last year's runup in gas prices. Also, tax refunds through March are up nearly 30% from last year. Over the past six months, public support has more than offset lost labor income: Wage-and-salary income has fallen by $89 billion, but government transfers have increased by $127 billion.
Washington's $787 billion stimulus package offers further substantial income support starting this month. The Making Work Pay tax credit, mostly paid out via lower withholding, will boost take-home pay for lower and middle income families. Another feature of the package is a one-time $250 payment in May to all Social Security recipients. Together these two programs will add about four percentage points to the annualized growth rate of aftertax income in the second quarter.
In addition to government help, falling gas prices have lifted buying power, while the combination of sharply lower mortgage rates and Washington's housing program are encouraging refinancing, which is putting more money in people's pockets. Spending also turns on consumer confidence, which may have found a floor thanks to hopeful signs from Wall Street and a few recent economic reports.
Economists are quick to note that much of the income support consumers are now getting will have faded by the second half. The withholding boost and Social Security COLA will continue, but the effect on income from the one-time Social Security payment will reverse in the third quarter. Also, inflation will pick up, as the gasoline effect plays out, creating a drag on buying power. Plus, households are still saving more of their incomes as they deal with lost wealth.
All this means job markets need to stabilize in the second half. However, stanching the flow of job losses depends on the success of government programs in shoring up both consumer spending and business expectations. In March the Business Roundtable's CEO Economic Outlook Index fell to the lowest level since the survey began in 2002. The CEOs said improved consumer confidence and demand are crucial to jump-starting the economy.
Right now a growing number of economists believe, because of Washington's efforts, the worst of the recession may soon be over. The real trick, though, will be to convince business executives.