Personal Income and Spending for November

The government released its estimate of personal income and spending for November and it contained some pretty good news (good is relative nowadays!).  Real disposable income rose by 0.8% while real consumer spending rose by 0.6% (reflecting an inflation rate of -0.2% for the month due to declining energy prices).  The report confirms that Hurricane Sandy contributed to the weakness in October, so the November figures reflect a bounceback from a temporarily depressed level.  If one takes a 3-month average, real disposable income is growing at an annualized rate slightly in excess of 3% (mainly driven by November's surge) while real consumer spending is growing in excess of 3.5% (annualized).  The personal savings rate rose to 3.6% (from 3.4%).  On the inflation, both core and overall inflation are approximately 1.5% (overall inflation is 1.4% over the past year; core inflation is 1.5%).

The surprise from the report was the surge in real disposable income.  Though some of it reflects a bounceback from Sandy, real disposable income has increased by 2.5% in the last 12 months, the highest year-over-year change since March 2011.  If this is sustained, consumers may be better able to handle tax hikes than previously thought.  It gets a little complex, but it's doubtful whether this pace will be sustained since it reflects depressed income in November 2011 and a surge in November 2012.  Of course the big issue is how the resolution to the fiscal cliff will affect disposable personal income.  Given the likelihood of the end of the payroll tax cut and higher taxes on upper-income individuals, real disposable income will take a significant hit in early 2013.  The size of the impact on consumer spending will determine how weak the economy will be in the first half of next year.

Fed announcement: 12-12-12

The Fed broke more new ground today in it's policy announcement.  As expected, with the end of Operation Twist (selling short-term securities and buying long-term securities), it now plans to purchase long-term Treasuries ($45 billion per month) in addition to $40 billion worth of mortgage-backed securities each month.  If you do the math, that's about $1 trillion per year (for comparison purposes, net purchases were $2 trillion over the past 4 years).  How long will continue with such a loose monetary policy?  Rather than saying until things get better, the Fed got specific.  To quote:

"the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

Ben Bernanke will discuss this at his news conference this afternoon, but here's what they're thinking.  Inflation is low and is expected to remain low for quite a while.  The Fed is comfortable as long as inflation stays close to its medium-term target of 2%.  Specifically, high inflation is now defined as a medium-term forecast exceeding 2.5% (medium term means 1 to 2 years from now).  In addition, inflation expectations need to be contained (not sure what their gauge will be, but possibly based on the TIPS market).  Assuming that inflation is under control, the Fed will keep the federal funds rate between 0-0.25% as long as the unemployment rate is above 6.5%.  Why 6.5%?  The Fed considers NAIRU to be between 5.2% and 6%.  What does that mean?  The Fed thinks unemployment would have to fall below NAIRU for there to be upward pressure on inflation; 6.5% gives it a cushion given that monetary policy takes some time to have an effect (and takes some time to reverse those effects). 

Key points:

• So rather than stating that interest rates will remain low until the economy improves or as long as inflation is contained, the Fed has now stated what that means.  Recall that the Fed has a dual mandate - low inflation and low unemployment.  It now has stated specifically how achieving both parts of that mandate will guide their policy in the coming years.
• It should be noted that the Fed statement says the federal funds rate will remain low as long as unemployment is above 6.5% and expected inflation is less than 2.5%.  That doesn't necessarily mean that it will engage in quantitative easing (bond purchases) for that same period.
• When is unemployment is expected to decline to below 6.5%.  Based on the December Fed forecast, this will take place in 2015, while most private forecasters think that won't occur until late 2015 or 2016 (see my economic forecast page).

Black Friday as an Indicator of Holiday Spending

One of my most viewed posts in the last 12 months considered whether Black Friday sales provided a good indicator of holiday sales and consumer spending, so I decided to update it for 2012 (here's a link to update for the 2011 holiday season once all the data had become available).  Let's update the table given the performance of Black Friday in 2012 (numbers in parentheses reflect sales after adjusting for inflation):

 

Year	Black Friday*	Holiday Sales	Consumption Q4
2012	+2.7% (+1.0%)	?	?
2011	+6.6% (+4.0%)	+4.1% (+1.5%)	+2.0%
2010	+0.3% (-1.0%)	+5.2% (+3.9%)	+3.6%
2009	+0.5% (-1.0%)	-0.4% (-1.9%)	+0.4%
2008	+3% (+1.3%)	-2.8% (-4.5%)	-5.1%
2007	+8% (+4.5%)	+2.4% (-1.1%)	+1.2%
2006	+6% (+4.1%)	+4.6% (+2.7%)	+3.8%

*Black Friday weekend (Thurs-Sun) was used for 2012
note: data for Black Friday sales comes from ShopperTrak; Holiday Sales comes from the National Retail Federation; Consumption comes from the BEA (Commerce Dept)

You'll note one change in the table.  Given the increased relevance of Thanksgiving Day sales, Black Friday weekend was used for 2012 (sales for Black Friday declined in 2012 as many people shopped on Thanksgiving night instead of Black Friday).  Is the relatively small increase in sales this year a bad sign for the holiday shopping season?  As the table indicates, Black Friday sales tend to be a poor indicator of holiday sales and consumer spending, so there's hope.  On the flip side, in five of the previous six years, Black Friday sales rose more than holiday sales (exception was 2010), so the weakness may be a precursor for weak sales this year.

Why the weakness so far in 2012?  One reason is the growth in personal income.  Over the past 12 months (Oct 2011-Oct 2012), total real personal income (i.e., income adjusted for inflation) rose by 1.4% (note: this is total personal income, not the average per household).  How does that compare to previous years?  It rose by 1.9% for the comparable period in 2011 and 4.1% in 2010.  Thus, real personal income has outperformed Black Friday sales as a predictor of holiday spending.  A 4.1% increase in income led to a 3.9% increase in holiday spending in 2010 while a 1.9% increase in income led to a 1.5% in holiday spending in 2011.  What does that imply for 2012?  Based on recent patterns, a 1.4% increase in real personal income suggests a 1% to 1.2% increase in holiday spending for 2012, which is what happened to Black Friday sales (rose by 1%).

Maybe Black Friday sales will prove to be a good indicator of holiday sales this year after all?  We'll know soon.

November Employment Report

The headlines from the November employment report were a decline in the unemployment rate to 7.7% along with an increase of 146,000 jobs.  You know what's next; there's more to it as one delves into the details.  Why did the unemployment rate decline?  We're back to the story that has played out in recent years - there were fewer people participating in the job market.  For people to be considered unemployed, they need to be actively seeking a job.  In November, 350,000 people dropped out of the labor force.  If the labor force had remain unchanged, the unemployment rate would have ticked up to 8% (technically, 7.95%, but rounded up to 8%).  The decline in the participation rate reversed the gain in October and put us close to a 30-year low (it was 63.6% in November, slightly above the recent low of 63.5% in August 2012, which was the lowest since 1981).

On the job front, the surprise was that Sandy had little impact (the report explains that the impact nationally was minimal, but there may have been some impact in the region; it should be noted that the data for employment was collected about 2 weeks after Sandy hit the northeast).

What stood out in terms of job creation?  Retail trade added 52,600 jobs (and over 100,000 in the last 2 months), led by an increase of 33,300 in clothing stores.  Most of the other gains were spread out across the service sector.

What's the takeaway?  The economy continues to add jobs at a modest pace (averaging about 150,000 per month).  Though this seems OK, it mainly reflects our lowered expectations.  The decline in the unemployment rate is welcome, but still mainly reflects fewer people participating in the job market.  The unemployment rate peaked at 10% in October 2009.  Since then the participation rate has declined from 65% to 63.6%.  If it had remained unchanged, the unemployment rate would currently be 9.7%.  Some of the decline is due to demographic factors (i.e., baby boomers retiring, etc.), but some of it is due to people giving up looking for work due to the weak economy.

Fiscal Cliff - The Big Picture

What combination of tax increases and spending cuts should be used to reduce the deficit?  Who should make sacrifices?  Do we need to make significant reductions in the deficit right away or over time?  While it's tempting to get bogged down in the details, it's important to step back and see the big picture. The fiscal cliff came about over concerns about the budget deficit and national debt. However, from an economic point of view, the goal is not to balance the budget and/or reduce the national debt. Instead, the goal is to try to achieve strong and sustainable economic growth over time (which should increase the average standard of living and thus improve the lives of people). High deficits and debt are a threat to sustainable economic growth, whether through crowding out of investment (i.e., making it more difficult for business to purchase necessary equipment, structures, etc), crowding out of government programs or tax reductions (due to having the pay more interest on a growing debt), or risking a sovereign debt crisis. Thus, any policy designed to control the budget deficit should take into account how it affects economic growth over time.

Policies to reduce the budget deficit are likely to reduce economic growth in the near term, thus most economists suggest an approach that has a small effect initially, but is generally seen as resulting in significant deficit reduction over time. To summarize, the following are generally agreed to be elements of a successful package:

• credible deficit reduction plan that has a larger impact in the medium to long run
• does little harm or promotes long-run economic growth (i.e., does not discourage increases in human capital, physical capital, or technological development)
• accounts for non-economic values (people may differ on these; they may include phasing in changes to programs like Social Security, Medicare, etc., since current retirees and those approaching retirement made plans based on the current system; also, there are issues of efficiency vs. equity, ...)

What changes need to be made?  Given the results of the 2012 election, it is generally agreed that increasing tax revenue will be part of any deal. In a previous post, I discussed one proposal to limit the amount of deductions to $50,000, that is estimated to be able to raise more than $700 billion over ten years, 80% of which comes from the top 1%.  On the spending side, virtually all budget experts and economists recognize the need to reduce the growth of spending on entitlements, since that's the fastest growing part of the budget (note: though the graphic below is from the Heritage Foundation, a conservative organization, the underlying data is from the Congressional Budget Office and President Obama's Office of Management and Budget).



Other programs can be changed as well, but tax changes and reducing the growth of entitlement spending are essential components of any credible deficit reduction plan. The question remains, will there be the political courage to make the tough decisions and the necessary compromises?

Resources for Understanding the Fiscal Cliff

Given all the discussion about the Fiscal Cliff, it's important to understand what it is, how we got here, and why it's a problem.  As a reminder, the Fiscal Cliff involves the simultanteous expiration of the Bush tax cuts, the payroll tax cut, and mandatory cuts in defense and discretionary program beginning in January 2013.  What in the world does that mean?  The following are some useful resources for understanding the Fiscal Cliff.

• Video about the fiscal cliff (from the Wall Street Journal)
• The Fiscal Cliff: A Primer (Tax Foundation)
• Expiration of the Bush Tax Cuts
  • What are the Bush tax cuts?
  • What about me? A tax calculator that shows the impact of the expiration of tax cuts.
• How we got to this point (Pete Peterson Foundation) - analysis of budget agreement that raised the debt ceiling in Aug 2011
• Sequestration: over $100 billion in spending cuts in 2013 - half in defense, half in other discretionary programs (not entitlements)
• Expiration of payroll tax cut (2% tax cut that was part of the stimulus in 2011 and 2012)
• Impact on the economy
  • CBO blog post summarizing the economic effects of the fiscal cliff
  • The Economic Impact of the Fiscal Cliff: An Update (Wells Fargo)
• Fix the Debt: a bipartisan organization designed to educate the public about the debt problem as well as to promote a credible plan to contain the growth of the national debt

In future posts, I'll discuss specific aspects of the Fiscal Cliff including the big picture as well as details as to what's involved, the current status, and the likely impact.

A Second Look at Third Quarter GDP

This morning, the government released revised estimates of third quarter GDP.  Though the headline number looks good (by today's standards!), there's less than meets the eye (no, I'm not trying to be negative).  Economic growth was revised up from 2% to 2.7%.  However, growth in consumer spending was revised down from 2% to 1.4% and business investment declined by 2.2%, its worst showing since 2009 (led by the first decline in investment in equipment and software since the end of the recession).  So why was economic growth revised upward?  Higher government spending, more inventories, and fewer imports (due in part to weaker consumer spending).  Private demand (i.e, excluding inventories and government spending) rose by 1.26%.

So what's the takeaway?  The economy continues to move forward, but slowly.  Consumer spending was sluggish in the spring and summer while business investment has weakened considerably.  The combination of rising inventories and modest consumer spending suggests limited production in the coming quarters as businesses seek to trim their inventories to get them back in line with sales.  Most forecasts estimate that the economy will remain sluggish through the middle of next year, growing by between 1.5 and 2% in the fourth quarter and between 1% and 2% in the first quarter of 2013 (see my forecast page).  Of course the what happens to the fiscal cliff will have a lot to say as to the direction of the economy as we enter 2013.  Given the likelihood of the end of the payroll tax cut, which will result in a 2% tax hike for most Americans beginning in January 2013, consumer spending will remain sluggish at best in the coming months.  Are there any bright spots?  Believe it or not, residential investment has grown by 13.7% in the last 12 months (from a depressed rate) and is now the fastest growing segment of the economy.