With the economic recovery running out of steam, it's not at all surprising that politicians and businessmen are calling on consumers to increase their spending. Since consumer outlays account for two-thirds of all the spending in our economy, a decision by consumers to spend more could provide the boost needed to get total gross national product growing more rapidly. With the utilization of capacity in our industrial and service sectors below par and declining, there is enough slack in the economy so that a mild boost in consumer outlays would raise output without creating renewed inflation.
If consumers do boost their purchases, businesses would increase production. That would mean fewer layoffs, longer hours worked and more new hires. Wage and salary incomes would therefore rise. And those higher incomes would soon get turned into more spending, giving a further boost to the economy. The consumer could indeed provide the spark for renewed expansion.
However, the attempts by politicians and businessmen to rally consumers to spend is unlikely to succeed by itself. Last month's surveys of consumer sentiment and Christmas shopping plans didn't give much hope for a rise in consumer outlays. And with the saving rate down to an incredibly low 3.7% of personal income, consumers don't have much room to raise spending.
Fortunately, the Federal Reserve isn't waiting around for the consumer to act spontaneously. Federal Reserve cuts in interest rates will stimulate increased consumer spending through several channels. Lower interest rates on mortgages will mean that more prospective home buyers will be able to afford a home and to meet the banks' mortgage qualifying standard. With the interest rate down, they can buy more housing without having to pay any more each month.
More home-buying means more housing construction and more production of home appliances and other consumer durables. For those individuals who already own a home with an adjustable-rate mortgage, lower interest rates mean lower monthly payments and therefore more income available to spend on other things. And market competition means that lower interest rates in general will eventually bring down credit-card interest rates without the harmful effects that would be caused by government-imposed limits.
We're optimistic that lower interest rates would boost consumer spending. At this stage of the business cycle, with the economy operating at well below capacity, the increase in consumer demand can mean more real output and higher real incomes.
But there's a time to spend and a time to save. It's important to remember that an increase in consumer spending is helpful only because of the temporarily depressed state of the economy. When we get out of the current economic downturn and the unemployment rate declines to about 6%, further increases in consumer spending cannot raise real output and boost real incomes. At that point, more consumer spending by itself would only increase inflationary pressures or suck in more imports from abroad or reduce investment in plant and equipment.
When the downturn is over, further growth in output and in the standard of living will depend on increases in productivity. Experience shows that the primary way in which an economy can raise productivity is through investment in new plant and equipment--better machinery in factories, new equipment in offices, more modern transportation and communication systems, etc.
The key to increased investment is a higher rate of saving and, therefore, less consumer spending. In other words, although consumers can help the economy in its currently depressed state by spending more, once the downturn is over the roles of spending and saving will be reversed. Consumers must then gradually reduce their spending and save more.
The United States has had the lowest rate of economic growth among the major industrial countries of the world for the past several decades because we have had the lowest rate of saving and investment. The long-term imperative is to raise national saving so that we can increase the share of output devoted to productive investments.
Perhaps a year from now, when the economy has recovered and the political distortions of an election year are past, the new Congress and the President can agree on a package of tax changes that will spur consumers to raise saving and businesses to increase investment.