In the US, firms are hiring at their fastest pace in more than eight years but spending hasn’t followed suit. A range of cyclical and structural factors can account for this and -- although while some of them are only temporary -- they suggest that US household spending will not be the source of growth that it once was.
The relationship between jobs and spending is usually fairly straightforward. Higher employment equals higher incomes (whether in aggregate or via higher wages) and that results in greater household spending.
By that measure, the US household sector should be well placed to spend heavily over the remainder of the year. US non-farm payrolls have increased by 200,000 for six straight months, marking the strongest period for the labour market in more than eight years.
Yet despite that, spending continues to disappoint. Real personal consumption fell by 0.2 per cent in July, missing market expectations, to be 2 per cent higher over the year. This follows relatively poor results in both the March and June quarters.
So what’s going on here and is it likely to change?
Pinpointing an exact reason is difficult -- developments across an entire economy rarely have a singular cause -- but there are a few structural and cyclical factors that may help explain the modest response from households since the onset of the global financial crisis.
First, for many households refinancing or paying down existing debt remains a priority. The US household debt-to-GDP ratio fell by 1.5 percentage points over the year to the March quarter 2014. The pace of de-leveraging has certainly slowed over the past few years but with the threat that rates may rise next year, households will be keen to reduce their debt burden while rates remain at historic lows.
This, combined with massive job losses, largely killed off the household sector’s debt-fuelled spending boom throughout the 1990s and 2000s. Between 1990 and 2008, household consumption as a share of real GDP rose from 63 to 68 per cent but has since stagnated.
Second, income growth remains subdued. Average hourly earnings -- a less volatile measure of income compared with the graph above -- has struggled to outpace inflation over the past five years.
Third, job growth has been concentrated in lower paid sectors such as fast food, administration and retailing. According to a report by the National Employment Law Project, lower-wage sectors accounted for 22 per cent of the job losses during the recession but 44 per cent of employment growth through to February this year.
Fourth, the US real exchange rate has deteriorated sharply since the mid-2000s, reducing the purchasing power of US households. A low exchange rate has helped support export industries but it has come partially at the expense of households who find that their income no longer goes as far as they once did.
Fifth, the failure by Congress at the beginning of this year to extend emergency unemployment benefits to the millions of long-term unemployed continues to weigh on spending. According to estimates from the Congressional Budget Office, cutting unemployment benefits could reduce real GDP by around 0.2 percentage points in 2014 (Why tough love on US unemployment isn’t working; May 27).
Sixth, demographic factors are also playing a part. The ‘baby boomers’ began to retire in 2011, resulting in a sharp rise in the share of the population aged over 65, which has weighed on household spending since older households tend to spend a lower proportion of their income.
Finally, rising inequality may also be playing a role. Research shows that, compared with low-income earners, wealthy households tend to spend a lower proportion of their income and existing wealth. Furthermore, most of the gains in asset prices, particularly shares, have accrued towards wealthier households.
This list is far from exhaustive but it should provide a fair understanding of the challenges facing the US household sector. Factors such as wage growth, de-leveraging and the real exchange rate should begin to improve as the economy continues to recover.
Others such as inequality or the loss of unemployment benefits could be addressed via new legislation. Finally, factors such as their ageing population will be more difficult to overcome and may mark a more permanent shift in the level and composition of household spending.
Growth in the US should pick up over the remainder of 2014 but we shouldn’t necessarily expect the household sector to be the driving force. Struggling with high debt and poor wages, the household sector remains understandably cautious and most of the gains from the recovery have accrued towards the wealthy.
Strong employment should ease those concerns in time but structurally the household sector is poorly placed to replicate the level of growth that was the norm throughout the 1990s and early 2000s. For the US to return to pre-crisis growth, they will require a greater contribution from the business sector, higher public spending and a more competitive and productive exports sector.