11.03.2009 Policy Points

The Outlook for Consumer Spending

Personal consumer spending is the largest single contributor to the nation’s gross domestic product. While personal spending typically declines during a recession, the eventual rebound helps lead the economy out of recession.

Yet in today’s economy, a variety of factors make a robust rebound in consumer spending unlikely. In recent congressional testimony, scholar Karen Dynan of the Brookings Institution outlined the reasons why consumer spending growth will be muted in coming months. One of the factors likely to depress spending is a weak labor market recovery. Says Dynan:

One factor that will probably restrain consumption will be tepid growth in households’ labor income. As you know, the sharp decline in aggregate demand for output has led to one of the largest percent declines in employment since the Second World War. Payroll employment has fallen by more than 7 million since the recession began, and, although the rate of decline has abated in recent months, we are unlikely to see substantial gains in employment in the near future. When labor demand picks up again, firms are likely to increase workers’ average hours – which fell noticeably during the downturn – before increasing the number of workers they employ. Firms tend to pursue this strategy because raising hours is less costly and easier to reverse than hiring new workers if the recovery proves transient. Of course, longer workweeks would increase workers’ earnings, but the magnitude of this response is also likely to be muted.

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