More Spending In 2022, Cutbacks In 2024

Consumers in America will keep spending in 2022 despite inflation running higher than wage gains. Average hourly earnings increased 6.5% over the past 12 months, but the consumer price index rose 8.2%. This is not strictly an apple-to-apples comparison, but it certainly indicates budget challenges for those people who have been spending all of their income.

Although current income is usually a good predicter of current spending, past savings plays a role as well. And past savings are huge, as the chart above shows. People in the aggregate had saved $1.2 trillion in 2019. Then the stimulus checks arrived in 2020 and 2021. Savings jumped to $2.9 trillion and then settled down to “only” $2.3 trillion last year. So consumers saved hugely more than usual in the last two years. Some of this saving was additions to bank accounts, and some was paying down old debts.

Economists were not surprised that consumers saved most of their stimulus payments. Milton Friedman back in 1957 argued that spending decisions are primarily determined by “permanent income,” the income likely to be steady. Spending from transitory income would be much smaller. In rough summary, that’s what the economy experienced in 2020 and 2021.

The composition of spending further backed Friedman’s theory. He had argued that spending on durable goods, such as cars and appliances, was actually a way to transform current expenditures into a stream of services enjoyed over future years. So spending an unusual lump sum income on a durable product would be consistent with Friedman’s Permanent Income theory. In 2020 and 2021, durables goods were the fastest-growing portion of consumer spending.

For the future expenditures of American consumers, the theory and data point to continued spending in 2022 and 2023. The money that families and individuals received in stimulus payments (including the extra unemployment insurance payments), will be spent over a period of several years. That’s the positive side.

On the negative side, the surge in durable goods spending in the last two years may reduce demand for durables in the coming years. In common sense terms, everyone who might have bought a boat in 2023 if we had not had a pandemic already bought one in 2020 or 2021. That seems logical, but supply constraints limited purchases of cars, boats, bicycles, appliances and most other types of durables. As supply becomes more available, some of the stimulus money will be spent. Thus, expect spending on consumer durables to taper down gradually but not severely.

At the same time, consumers are increasing their spending on travel, dining out and other activities that are not socially distanced. This shift in spending patterns is throwing retailers into knots, as typified by Target’s recent earnings warning. Not all companies are ready for the shift, as stores have too many appliances in inventory and airlines too few pilots.

Eventually many consumers will tighten their belts. If inflation remains higher than wage growth, people will use up their past savings. People who moved out of shared space (with family or friends) to live without roommates may have to rethink their budgets, as noted in an article last month. Higher interest rates will limit big-ticket spending that is usually financed, such as cars and RVs. And the falling stock market will curb some extravagant expenditures. But interest rates and the stock market are minor effects.

The portion of current income that people consider to be permanent will have the largest impact. Higher wage rates feed into permanent income directly. One-time bonuses do not affect spending much, though routine annual bonuses certainly do. And past savings from stimulus payments will be doled out gradually, adding to permanent income in driving spending.

The consumer spending outlook for 2022 and 2023 is secure because of the high employment, high wages and past stimulus. Tightening of monetary policy will eventually lead to weak employment growth, or even declines. But monetary policy takes about a year to have its maximum effect on employment, and the Federal Reserve’s tightening is being implemented gradually. Thus 2023 looks pretty safe for jobs and spending.

Interest-sensitive spending will diminish in 2023, further weakening employment along with softer construction. Consumer spending does not suffer the worst when interest rates rise, but higher rates will certainly cool exuberant shopping.

Will the slower growth of consumer spending cause or contribute to a recession? If it were only consumer spending at work, no recession would be likely. Economic growth would slow modestly. Construction, however, is very interest-sensitive. Business capital spending is somewhat sensitive to interest rates. Asset values for stocks and real estate tend to decline as the Fed tightens, and lower asset values push spending down. All told, a recession is likely around 2024, though perhaps starting late in 2023 or being delayed until 2025, For 2022 and 2023, however, consumers look good and will keep the economy growing.