Collective Conscious

Marty Feld­stein:

Annual GDP rose by 3.2% and growth of final sales jumped to a remark­able 7.1% year-​​on-​​year rate. True, much of that was due to a sharp decline in imports; but even the growth rate of final sales to domes­tic pur­chasers rose at a healthy 3.4% pace.

The key dri­ver of the increase in final sales was a strong rise in con­sumer spend­ing. Real per­sonal con­sumer spend­ing grew at a robust 4.4% rate, as spend­ing on con­sumer durables soared by 21%. That meant that the accel­er­a­tion of growth in con­sumer spend­ing accounted for nearly 100% of the increase in GDP, with the rise in durable spend­ing account­ing for almost half of that increase.

The rise in con­sumer spend­ing was not, how­ever, due to higher employ­ment or faster income growth. Instead, it reflected a fall in the per­sonal sav­ing rate. House­hold sav­ing had risen from less than 2% of after-​​tax incomes in 2007 to 6.3% in the spring of 2010. But then the sav­ing rate fell by a full per­cent­age point, reach­ing 5.3% in Decem­ber 2010.

A likely rea­son for the fall in the sav­ing rate and result­ing rise in con­sumer spend­ing was the sharp increase in the stock mar­ket, which rose by 15% between August and the end of the year. That, of course, is what the Fed had been hop­ing for.

At the annual Fed con­fer­ence at Jack­son Hole, Wyoming in August, Fed Chair­man Ben Bernanke explained that he was con­sid­er­ing a new round of quan­ti­ta­tive eas­ing (dubbed QE2), in which the Fed would buy a sub­stan­tial vol­ume of long-​​term Trea­sury bonds, thereby induc­ing bond­hold­ers to shift their wealth into equi­ties. The result­ing rise in equity prices would increase house­hold wealth, pro­vid­ing a boost to con­sumer spending.

To be sure, there is no proof that QE2 led to the stock-​​market rise, or that the stock-​​market rise caused the increase in con­sumer spend­ing. But the tim­ing of the stock-​​market rise, and the lack of any other rea­son for a sharp rise in con­sumer spend­ing, makes that chain of events look very plausible.

The mag­ni­tude of the rela­tion­ship between the stock-​​market rise and the jump in con­sumer spend­ing also fits the data. Since share own­er­ship (includ­ing mutual funds) of Amer­i­can house­holds totals approx­i­mately $17 tril­lion, a 15% rise in share prices increased house­hold wealth by about $2.5 tril­lion. The past rela­tion­ship between wealth and con­sumer spend­ing implies that each $100 of addi­tional wealth raises con­sumer spend­ing by about four dol­lars, so $2.5 tril­lion of addi­tional wealth would raise con­sumer spend­ing by roughly $100 billion.

That fig­ure matches closely the fall in house­hold sav­ing and the result­ing increase in con­sumer spend­ing. Since US house­holds’ after-​​tax income totals $11.4 tril­lion, a one-​​percentage-​​point fall in the sav­ing rate means a decline of sav­ing and a cor­re­spond­ing rise in con­sumer spend­ing of $114 bil­lion – very close to the rise in con­sumer spend­ing implied by the increased wealth that resulted from the gain in share prices.