Hey consumer, keep on spending!

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Source: Author, 2022

The performance of The US economy is measured by GDP, or Gross Domestic Product. In order to understand why the consumer is so important to The US economy, let’s talk a little further about how GDP is measured.

GDP is the sum of four components, specifically Investment by Businesses, Government Spending, Net Exports and Consumption aka consumer spending. Or, in the form of an equation:

GDP = I + G + NX + C

Each component contributes to GDP, but how? Oh yes, that’s a great question! But to best answer it, let’s consider how GDP is impacted by changes we’re currently seeing in the US Economy.

Interest Rates in The United States, I, are increasing. As interest rates rise business investment falls. Also when interest rates are higher some companies and consumers go bankrupt. US Government Spending, G, rose sharply during the pandemic. The Biden Administration wants a further 7% increase in government spending. America runs a large trade deficit, so Net Exports, NX, is negative. In fact, America’s trade deficits are getting larger, so NX is increasingly negative.

The only component we haven’t discussed is Consumption, C, aka consumer spending. Consumer spending is a significant driver of the US economy, contributing almost 70% to US GDP. The chart below shows the percentage change in Consumer Spending from 2012 to 2022.

Consumer Spending, Source: Fred, Author, 2022

Pre-pandemic, the rate of Consumer Spending averaged an increase roughly 2.4% per year. Post pandemic we saw a brief spike in the rate of Consumer Spending, but it has fallen rapidly to a rate of 2.7% per year.

Consumer spending seems healthy, growing slightly faster than before the pandemic. But can the consumer keep spending in spite of surging inflation? Every 1% increase in inflation reduces consumption by roughly 0.58%. And robust post pandemic wage growth is now slowing.

So where is the money coming from? The chart below shows the Personal Savings Rate from 2012 to 2022.

Consumer Spending, Source: Fred, Author, 2022

Pre-pandemic, from 2012 to 2020, Americans saved roughly 7.3% of their disposable income. In April 2022 Americans saved roughly 4% of their disposable income. In response to inflation consumers are saving less. But where might they get money to spend from?

The chart below shows consumer debt, in billions of dollars, from 2012 to 2022.

Consumer Debt, Source: Fred, Author, 2022

During pandemic consumer debt fell to $741 billion dollars. But as of May 2022, consumer debt hit a record $864 billion dollars, or an increase of 17.6%, post pandemic. Consumers seem to be increasing borrowing.

CONCLUSION

Americans are spending more than before the pandemic. At the same time, they are saving less and borrowing more to continue spending. Consumer spending is a very large component of GDP. So for how long can the consumer save less and borrow more, simply to spend more?

I have no idea, but you had better hope the consumer keeps spending, America depending upon them!

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