Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, October 03, 2005

The Drop in Consumer Spending

Consumer spending dropped precipitously in August. Those who use what I term SNKM [the Simple Naive Keynesian Model] with fixed prices and interest rates will see this as a downward shift in planned spending and bad for the economy.

Others take a longer view. The increase in saving should increase the supply of lendable funds, ceteris paribus, thus leading to lower interest rates and stimulating investment spending. The increase in investment spending should just about offset the decrease in consumption spending, leaving not much change in aggregate demand but providing more capital for more future growth.

Jim Hamilton summarizes the situation well:

If over the short run the Fed prevents the fall in real interest rates that would be the natural economic response to the fall in consumption spending, the investment demand won't be there to replace the lost consumption spending.

And he is not all that optimistic:

Is the actual drop in consumption spending of $47 billion enough to qualify as a large, sudden change that's a cause for concern, or is it the small, gradual change that would be a good thing? The answer depends on what happens next. If this turns out to be all the drop in consumption that there is, then things will probably be OK and this would eventually prove to be a favorable development. But Barry Ritholtz sees the August consumption figures as the harbinger of a major shift. If he's right, will businesses and the Fed recognize it in time? Probably not.
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