I can point to a number of specific factors in this recession that are likely to weaken recovery. First, despite signs that consumer spending is stabilizing, the chance of strong and sustained consumption growth appears low. For years prior to the recession, households went on a spending spree of major proportions. This occurred during what has come to be called the “great moderation,” a period of about two decades when recessions were infrequent and mild, and inflation was low and stable. This may have lulled households into a false sense of security. The personal saving rate fell from around 8 percent two decades ago to almost zero in recent years as households financed their lifestyles by drawing on increasing stock market and housing wealth, and taking on higher levels of debt.
Now, the era of such low saving may be over. Falling house and stock prices have vaporized trillions of dollars in household wealth. The destruction of their nest eggs is prompting households to rebuild savings. The deleveraging of household balance sheets could restrain spending for years. Indeed, the personal saving rate is finally on the rise, averaging more than 4 percent so far this year. It wouldn’t surprise me if this effect persists, as the shock of the financial crisis convinces many households that they need to save higher fractions of their incomes for the long term. Of course, ultimately this would be good for economic growth, channeling resources from consumption to investment. That said, the transition could be painful if subpar consumption growth restrains the pace of economic recovery.
The above scenario is a big reason why I think the 2.1% increase in personal consumption expenditures last quarter was a misnomer -- or at least not the great sign that people think it was.