American consumers aren’t what they used to be — and that helps explain the plodding economic recovery. It gets no respect despite creating 14 million jobs and lasting almost seven years. The great gripe is that economic growth has been held to about 2 percent a year, well below historical standards. This sluggishness reflects a profound psychological transformation of American shoppers, who have dampened their consumption spending, affecting about two-thirds of the economy. To be blunt: We have sobered up.
This, as much as any campaign proposal, may shape our economic future. There’s an Old Consumer and a New Consumer, divided by the Great Recession. The Old Consumer borrowed eagerly and spent freely. The New Consumer saves soberly and spends prudently. Of course, there are millions of exceptions to these generalizations. Before the recession, not everyone was a credit addict; now, not everyone is a disciplined saver. Still, vast changes in beliefs and habits have occurred.
A Gallup poll shows just how vast. In 2001, Gallup began asking: “Are you the type of person who more enjoys spending money or who more enjoys saving money?” Early responses were almost evenly split; in 2006, 50 percent preferred saving and 45 percent favored spending. After the 2008-2009 financial crisis, the gap widened spectacularly. In 2016, 65 percent said saving and only 33 percent spending.
What’s happening is the opposite of the credit boom that caused the financial crisis. Then, Americans skimped on saving and binged on borrowing. This stimulated the economy. Now, the reverse is happening. Americans are repaying old debt, avoiding new debt and saving more. Although consumer spending has hardly collapsed, it provides less stimulus than before. (A conspicuous exception: light-vehicle sales, which hit a record 17.4 million in 2015).
Consider the personal savings rate: the difference between Americans’ after-tax income and their spending. If a household has income of $50,000 and spends $45,000, its savings rate is 10 percent. Here are actual figures. From 1990 to 2005, the savings rate dropped from 7.8 percent to 2.6 percent. Since then, the savings rate has risen; it was 5.1 percent in 2015.
Federal Reserve figures on debt tell a similar story. From 1999 to 2007, household borrowing (mainly home mortgages and credit card debt) increased nearly 10 percent annually, far faster than income gains. People mistakenly believed that they could safely borrow against the inflated values of their homes and stocks. Now, borrowing is subdued. In 2015, household debt of $14 trillion was unchanged from 2007. While many consumers borrowed, others repaid or defaulted.
The surge in saving is the real drag on the economy. It has many causes. “People got a cruel lesson about [the dangers] of debt,” says economist Matthew Shapiro of the University of Michigan. Households also save more to replace the losses suffered on homes and stocks. But much saving is precautionary: Having once assumed that a financial crisis of the 2008-2009 variety could never happen, people now save to protect themselves against the unknown. Research by economist Mark Zandi of Moody’s Analytics finds higher saving at all income levels.
In theory, it’s easy to replace lost consumer demand. In practice, it’s not so easy. Businesses could build more factories and shopping malls. But with weaker consumer spending, do we need them? More exports would help, but economies abroad are weak.
Government policies are also frustrated. The Fed’s low interest rates don’t work if people don’t want to borrow. Ditto for tax cuts. During the Great Recession, Congress enacted several temporary tax cuts to boost consumer spending. The effect was modest, as studies by Shapiro and his collaborators found. Take the case of the two-percentage-point suspension of the Social Security payroll tax in 2011 and 2012. Two-thirds of the tax cut went to saving and repaying debt — not spending.
Direct government spending (a.k.a. infrastructure) might work better as stimulus. But it, too, faces problems. A mere one-percentage-point increase in the savings rate would offset almost $140 billion in infrastructure spending. And despite increases, the savings rate could rise further. In 1980, it was nearly 11 percent, twice today’s level.
A bad outcome would be a vicious circle of rising saving and falling returns, leading disappointed households to save even more. Significantly, the McKinsey Global Institute, the consulting company’s research arm, predicts that future returns on stocks and bonds will be lower than in recent years. But it’s also possible, as Shapiro says, that accumulating levels of saving and repaid debt will reassure households and keep their spending growing at a steady, if boring, pace. That wouldn’t be such a bad result.
Whatever happens, the public and politicians should take note: This legacy of the Great Recession will endure. It has left a deep psychological scar that won’t soon heal.
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