October 02, 2010
The Washington Post headlined an article on the release of data August consumer spending: “with consumers skittish, hopes muted for holiday sales.” The article goes on to describe weak consumer sales, which are explained by pessimistic attitudes about the economy.
In fact, consumer sales are actually quite strong given the level of income. As the article notes, the saving rate for August was 5.8 percent. This is considerably below the average for the 50s, 60s, 70s, and 80s. In each of these decades the savings rate was considerably above 8.0 percent.
The saving rate began to drop toward the end of the 80s and into the 90s as a result of the wealth effect generated by the stock market bubble. It fell to zero as a result of the wealth effect from the housing bubble. Now that most of this bubble wealth has disappeared, it would be expected that the savings rate would return to its normal level or possibly even rise above it, as households attempt to make up for lost wealth. This is especially likely given that the huge cohort of baby boomers is approaching retirement with virtually no wealth and there is widespread talk of cutting their Social Security benefits.
It is remarkable that the Washington Post could not find any economists familiar with the wealth effect on consumption. It is one of the most basic relationships in economics.
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