As is often the case, the ability and willingness of households to spend will be an important determinant of the pace at which the economy expands in coming quarters. Although real consumer spending rose moderately last quarter, households continue to face significant headwinds. Notably, real household income and wealth stagnated in 2011, and access to credit remained tight for many potential borrowers. Consumer sentiment has improved from the summer's depressed levels but remains at levels that are still quite low by historical standards.
Total net worth of households is still below pre-recession levels. While it has risen from low levels, it dipped last month and is barely above year ago levels.
As we have been documenting here for some time, consumers have been paying off credit for most of this recovery. The last two quarters, we have seen an increase, however.
Real disposable personal income has been stagnating for the recovery. As a result,
income for new purchases is coming from personal savings.
Household spending will depend heavily on developments in the labor market. Overall, the jobs situation does appear to have improved modestly over the past year: Private payroll employment increased by about 160,000 jobs per month in 2011, the unemployment rate fell by about 1 percentage point, and new claims for unemployment insurance declined somewhat. Nevertheless, as shown by indicators like the rate of unemployment and the ratio of employment to population, we still have a long way to go before the labor market can be said to be operating normally. Particularly troubling is the unusually high level of long-term unemployment: More than 40 percent of the unemployed have been jobless for more than six months, roughly double the fraction during the economic expansion of the previous decade
There are three important charts here.
the 4-week average of initial unemployment claims continues to move lower. The last month and a half, we've seen this number move significantly lower.
While the total number of employees is still far below previous levels, this trend is moving in the right direction.
The unemployment rate is moving lower, although it is still at uncomfortably high levels.
Uncertain job prospects, along with tight mortgage credit conditions, continue to hold back the demand for housing. Although low interest rates on conventional mortgages and the drop in home prices in recent years have greatly improved the affordability of housing, both residential sales and construction remain depressed. A persistent excess supply of vacant homes, largely stemming from foreclosures, is keeping downward pressure on prices and limiting the demand for new construction.
In response, I would point out that CR has argued for a bottom in housing -- a sentiment while I wrote about last May (I was a bit early) and which NDD has been all over (see here, here and here) as examples.
In contrast to the household sector, the business sector has been a relative bright spot in the current recovery. Manufacturing production has increased 15 percent since its trough, and capital spending by businesses has expanded briskly over the past two years, driven in part by the need to replace aging equipment and software. Moreover, many U.S. firms, notably in manufacturing but also in services, have benefited from strong demand from foreign markets over the past few years.
Industrial production -- which crashed as a result of the contraction -- has been steadily making its way back. While we're still not at previous levels, we continue to get closer.
An untold story during this expansion has been the incredibly strong rate of investment by businesses, which is now at higher levels than the previous expansion in real terms.
More recently, the pace of growth in business investment has slowed, likely reflecting concerns about both the domestic outlook and developments in Europe. However, there are signs that these concerns are abating somewhat. If business confidence continues to improve, U.S. firms should be well positioned to increase both capital spending and hiring: Larger businesses are still able to obtain credit at historically low interest rates, and corporate balance sheets are strong. And, though many smaller businesses continue to face difficulties in obtaining credit, surveys indicate that credit conditions have begun to improve modestly for those firms as well.
Interest rates are incredibly cheap by historical standards.
Globally, economic activity appears to be slowing, restrained in part by spillovers from fiscal and financial developments in Europe. The combination of high debt levels and weak growth prospects in a number of European countries has raised significant concerns about their fiscal situations, leading to substantial increases in sovereign borrowing costs, concerns about the health of European banks, and associated reductions in confidence and the availability of credit in the euro area. Resolving these problems will require concerted action on the part of European authorities. They are working hard to address their fiscal and financial challenges. Nonetheless, risks remain that developments in Europe or elsewhere may unfold unfavorably and could worsen economic prospects here at home. We are in frequent contact with European authorities, and we will continue to monitor the situation closely and take every available step to protect the U.S. financial system and the economy.
Let me now turn to a discussion of inflation. As we had anticipated, overall consumer price inflation moderated considerably over the course of 2011. In the first half of the year, a surge in the prices of gasoline and food--along with some pass-through of these higher prices to other goods and services--had pushed consumer inflation higher. Around the same time, supply disruptions associated with the disaster in Japan put upward pressure on motor vehicle prices. As expected, however, the impetus from these influences faded in the second half of the year, leading inflation to decline from an annual rate of about 3-1/2 percent in the first half of 2011 to about 1-1/2 percent in the second half--close to its average pace in the preceding two years. In an environment of well-anchored inflation expectations, more-stable commodity prices, and substantial slack in labor and product markets, we expect inflation to remain subdued.
PPI has spiked higher, but has recently moved lower. In addition, PPI rarely bleeds through to CPI -- or, perhaps more appropriate, CPI has a good track record of absorbing PPI increases without passing them onto the consumer.
The above chart shows CPI and PPI. While PPI has wilder swings, they rarely bleed through to CPI.
The above chart is the YOY percentage change in CPI. It shows that prices are contained.
