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Posts Tagged ‘Consumers’

The Federal Reserve reportedly wants consumer inflation of about 2 percent per year, as measured by the personal consumption expenditures price index, affectionately known as the PCE. By that standard, Fed policy appears too tight, despite near-zero rates and ongoing QE:

PCE Inflation - March 2013

Over the past year, the headline PCE (dashed blue line) has increased only 1.0 percent, and the core PCE (orange line) is up only 1.1 percent. The core PCE strips out often-volatile food and energy prices not, as some wags would have it, because economists don’t drive, eat, or heat their homes, but because the resulting series appears to be a better predictor of future inflation trends (i.e., less noise, more signal).

At the moment, both measures are close together — and far below the Fed’s alleged target.

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“American investors lack basic financial literacy,” according to a new report from the Securities and Exchange Commission (much of which is based on an earlier report by the Congressional Research Service at the Library of Congress). Many fail to grasp compound interest, don’t understand fees and other investment costs, and aren’t aware about the risks of investment fraud.

From the report summary:

According to the Library of Congress Report, studies show consistently that American investors lack basic financial literacy. For example, studies have found that investors do not understand the most elementary financial concepts, such as compound interest and inflation. Studies have also found that many investors do not understand other key financial concepts, such as diversification or the differences between stocks and bonds, and are not fully aware of investment costs and their impact on investment returns. Moreover, based on studies cited in the Library of Congress Report, investors lack critical knowledge about investment fraud. In addition, surveys demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population. The Library of Congress Report concludes that “low levels of investor literacy have serious implications for the ability of broad segments of the population to retire comfortably, particularly in an age dominated by defined-contribution retirement plans.”

The report goes on to discuss ideas for increasing financial literacy and increasing the transparency of fees and other investment costs.

People sometimes talk about financial literacy as though the goal is helping people choose their own investments. That can be helpful, but the report rightly discusses another goal: improving consumers’ ability to work with financial advisors.

P.S. For a brief discussion of financial literacy and mortgages, see this post from 2010.

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Early Friday, the Bureau of Economic Analysis released its third look at economic growth in the first quarter. The results were disappointing: BEA now estimates that Q1 growth was only 2.7%, down from the prior estimate of 3.0%. A key reason: consumer spending was weaker than previously thought.

As I noted in May, the monthly release of GDP data is inevitably followed by commentators claiming that “consumer spending makes up 70% of the U.S. economy” (see, for example, here). Unfortunately, that isn’t right. Consumer spending appears to be about 70% of the economy based on a seemingly obvious calculation (consumer spending divided by GDP), but that ignores the way that macroeconomic accounting handles imports. For reasons detailed in my earlier post, careful analysis suggests that the actual ratio is about 60%.

One reason the 70% error is so common is that doing the correct calculation requires a great deal of work; for example, you need to estimate the fraction of consumer purchases that come from imports. If we want commentators to start using the right figure, we need an easier way to get the idea across using the information reported in the headline GDP release.

Here’s one idea: Compare consumer spending to a measure of overall demand. To do so, we start with the usual macroeconomic identity:

GDP = C + I + G + X – M,

which says that GDP equals Consumer spending, Investment, Government spending, and eXports minus iMports (which are subtracted to avoid double-counting). Looking at this identity, you see that C, I, G, and X can be viewed as measures of demand from consumers, businesses, governments, and overseas markets, while M is a measure of supply from overseas producers.

To get a more reasonable measure of the importance of consumer spending, we can calculate what share of “overall demand” (C + I + G + X) comes from consumers. As shown in the chart, that measure (in red) has been roughly 60% for decades. The usual, misleading measure of consumer spending’s importance (in blue), however, has been up around 70% over the past decade, but used to be lower back when imports were smaller.

The C / (C + I + G + X) measure of consumer spending’s importance is hardly exact. For example, it doesn’t consider how much consumer spending actually comes from imports. However, it’s the simplest measure I could think of that comes close to the right answer. But maybe readers have an even better idea?

P.S. Thanks to Cornelia Strawser for helpful discussion of this measurement challenge.

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Journalists, commentators, and economists often say that consumer spending makes up 70% of the U.S. economy. Indeed, it’s easy to find several examples of that claim in today’s coverage of the latest GDP data (e.g., here). And, full confession, I’ve used that phrase a few times myself.

There’s just one problem with the 70% claim: it’s wrong. Consumer spending actually makes up only 60% of the economy.

This discrepancy exists because national income accounting doesn’t always mix well with simple arithmetic. If you look at data for 2009, you will find that consumer spending totaled $10.1 trillion, while GDP was $14.3 trillion, both measured in current dollars. Put those together, and it appears that consumer spending is about 71% of the economy (= 10.1 / 14.3). (You get almost the exact same percentage if you do the calculation with real values, but that introduces other complexities.)

That calculation is so simple, it’s easy to understand why it has a fan club. But there’s a hidden problem. To see it, it helps to do the same calculation for other parts of the economy. Again using current dollar figures for 2009, you will find the following:

     Consumer Spending            71%
     Investment                            12%
     Government                          21%
     Exports                                    11%

Notice anything strange? If you add these four sectors of the economy together, you discover that they account for 114% of GDP. In other words, consumer spending, investment, government spending, and exports, when combined, are one-seventh larger than the total economy.

This apparent paradox—the components of the economy are bigger than the economy itself—is resolved when you consider how the economic data handle imports. In order to determine gross domestic production, the statisticians add up domestic purchases and then subtract imports. So the full national income accounts for 2009 show the following shares of the economy:

     Consumer Spending           71%
     Investment                            12%
     Government                          21%
     Exports                                    11%
     Imports                                 -14%

These figures add to 100%, as they should. They also demonstrate why consumer spending was not really 71% of the U.S. economy in 2009. Total consumer spending was indeed 71% of the size of the economy, but part of that spending went to imported goods (clothes, coffee, cars, etc.). If you want to know how much consumers contributed to U.S. GDP, you need to take the 71% figure and then deduct the portion that was spent on imports.

I am not aware of a simple way to do this calculation using the data in the regular GDP reports. Over at Mandel on Innovation and Growth, however, Michael Mandel provides a useful discussion of a paper that does this calculation for several recent years, including 2008. (Michael deserves credit for taking a leading role in fighting back against the claim that consumers are 70% of the economy.)

The paper, “Induced Consumption: Its Impact on Gross Domestic Product (GDP) and Employment” by Carl Chentrens and Art Andreassen (you can find it in this conference proceeding) makes exactly the import adjustment I described above. For 2008, it concludes that the relative shares are as follows

                                        Unadjusted                   Adjusted

Consumer Spending           71%                           61%
Investment                            14%                           11%
Government                         20%                           17%
Exports                                   12%                            11%
Imports                                 -17%

The authors find similar results in previous years, including 1999, 2002, and 2006.

Bottom line: Consumer spending really makes up about 60% of the U.S. economy. But you’d be hard-pressed to know that from the usual GDP data.

Note: The authors make a second adjustment for “induced activity”, that Michael Mandel also picks up on. That makes the consumer share seem even smaller. I have serious reservations about that adjustment, however, particularly when trying to answer questions about (a) the overall size and composition of the economy and (b) its long-term growth. Thus, I favor the 60% figure.

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A new working paper from the Atlanta Fed identifies a key reason why some subprime mortgage borrowers have defaulted and some haven’t: differences in numerical ability (ht: Torsten S.).

In “Financial Literacy and Subprime Mortgage Delinquency,” Kristopher Gerardi, Lorenz Goette, and Stephan Meier examine how the financial literacy of individual subprime borrowers (as measured through a survey) relates to mortgage outcomes. They find a big effect:

Foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts.

20 percent of the borrowers in the bottom quartile of our financial literacy index have experienced foreclosure, compared to only 5 percent of those in the top quartile. Furthermore, borrowers in the bottom quartile of the index are behind on their mortgage payments 25 percent of the time, while those in the top quartile are behind approximately 10 percent of the time.

Interestingly, this effect is not due to differences in the mortgages that borrowers selected (e.g., it’s not that the less-numerically-able chose systematically bad mortgages*) or obvious socioeconomic factors (e.g., it’s not that the less-numerically-able had lower incomes).

Instead it appears that the less-numerically-able are more likely to make financial mistakes once they have their mortgages. As the authors note, this conclusion is consistent with other studies that examine how financial literacy relates to saving and spending choices over time. All of which is further evidence of the potential benefits of better financial (and numerical) education.

* The authors note one caveat on the conclusion about mortgage terms: The survey covered “individuals between 1 and 2 years after their mortgage had been originated,” but many subprime defaults happened more quickly than that. As a result, their results don’t address whether financial literacy played a role in determining which borrowers ended up in mortgages that blew up very rapidly.

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The holiday shopping season is now underway. According to the Wall Street Journal, consumers spent about $10.66 billion on Black Friday, a smidgen higher than last year.

And what does that portend for the holiday season and the economy overall? Short answer: No one knows.

As Karen Dynan notes in today’s Washington Post, the link between Black Friday sales and holiday sales isn’t as tight as many people think. And the link between holiday sales and the overall economy is even weaker. Those are two of the “5 Myths about Holiday Spending Sprees” that Karen identifies.

Her bottom line? “Much of the conventional wisdom linking holiday spending and the health of our economy turns out to have been exaggerated.”

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