American Consumers No Longer Support Growth

Recovery from Covid’s lockdowns had its greatest force among households. Home buying boomed, and homebuilding followed. Retail purchases soared in every major category. But that pictured has now changed. Rising interest rates have made home ownership too expensive for many. Inflation has cut deeply into the buying power of people’s incomes, and real spending has slowed accordingly. Now looking into 2023, prospects hardly point in the direction of growth and prosperity. Instead, they point to a developing recession, if the economy is not already in one.

Home buying and home building had led in the months following the worst of the pandemic lockdowns. During the second half of 2020 and in 2021, purchases of new homes leaped upward. By the end of 2021, buying was running some 25% above pre-pandemic levels. Construction tried to keep up with the buying. Starts of new housing units had risen by the end of 2021 some 24% above pre-Covid levels.

This year, both activities became casualties of rising interest rates, as inflation forced the Federal Reserve (Fed) to tighten credit. Since last March, when the Fed began its counter-inflationary efforts, rates on a 30-year mortgage have more than doubled, rising from a low of 3.29% to 6.5-7.0% recently. Not surprisingly, home ownership has become too costly for many Americans. Home purchases have tumbled, falling some 9.5% from March through November, the most recent month for which data are available. New construction starts followed, dropping 16.8% over the same time.

Declines in homebuying and building have directly affected consumer spending, especially sales of furniture and appliances as well as home repair supplies. But consumer spending has suffered even more from the burdens imposed by inflation on real incomes.

Even though wages have risen at historically rapid rates, inflation has increased living costs still faster. During the first three quarters of 2022, the Commerce Department reports that household incomes from wages and salaries rose at a 6.2% annual rate. Consumer prices, however, rose at an 8.0% annual rate during that time, more than offsetting the purchasing power of their expanded incomes. For a while, people tapped their credit cards to keep up their spending, but such behavior can only go so far. They had to slow the pace of new purchases. So, while retail sales during the first half of 2022 rose at an impressive 9.0% annual rate, they have barely grown at all in nominal terms since June. After accounting for the effects of inflation, real sales have actually declined.

Especially disturbing in this slowdown is the wide pattern of decline so evident in the recent retail sales figures. In December overall nominal sales fell 1.1% from November’s level, 12.3% at an annual rate. Only four of the twelve major categories showed any nominal growth at all, much less real growth. Sales of big-ticket items had the steepest declines. Auto sales fell 1.2% in December alone. Furniture sales fell 2.5% for the month, and electronics fell 1.1%. This is telling because consumers, when they feel strapped, cut back on these sorts of big-ticket outlays first. Spending on such things is easier to postpone than spending on everyday things, such as soap or groceries, medicine and the like. And indeed, food, was one of the four categories to show any increase.

True, December is just one month, and a single month’s figures do not a trend make. But November looked much the same. Usually, the overall figure – whether encouraging or disappointing – consists of a mix of growth in some categories and declines in others. That is to be expected, since households typically hold back on one kind of spending when they splurge on another. The month when a working family buys a car is the month when it decides to dine out less than usual. It is then telling that December and November universally saw cutbacks. This fact and the more general trends point to more of the same as the economy enters 2023.

If this is not a pretty picture, the cause of the economic trouble does offer reason to look for recovery later in 2023. If the Fed’s efforts can restrain inflation – not entirely unlikely – households could easily return to more aggressive spending patterns. Success on inflation might also prompt the Fed later in the new year to ease on its policies of credit restraint and perhaps reverse its present policy of hiking interest rates. That might foster a return to homebuying and building, if not in late 2023 then in 2024. The stage is set for recovery in time, but pain is likely in the next six to nine months.