2010 outlook coverage

Consumer behavior key to recovery

By James Overstreet
Posted December 13, 2009 at midnight

The Great Distrust is how Robert Rasche refers to last year's financial meltdown.

And if you were to trace the family tree of the Great Distrust, its mother would be the Great Moderation, its grandmother the Great Inflation and its great-grandmother the Great Depression.

And so the question now is whether the Great Distrust has given way to a sustainable recovery, says Rasche, executive vice president and senior policy adviser at the Federal Reserve Bank of St. Louis.

"We had a financial crisis because everybody lost confidence in all of their counterparties," Rasche told another packed hall at the Holiday Inn at the University of Memphis, where the Economic Club of Memphis held its annual Economic Outlook Breakfast. "That led to a brief panic, which generated a global recession and now -- hopefully -- a sustained recovery."

Rasche says the feared double-dip recession is unlikely, but a strong consumption-led recovery -- which has marked the end of every recession in modern history -- is also unlikely.

"The risk on the downside is that consumers are highly levered and we see some evidence that they are retrenching from that leverage," Rasche says. "On the upside, recent retail sales have been better than expected and better than last year."

Most economists focus on consumption because it is 70 percent of the gross domestic product -- the value of all goods and services produced annually nationwide.

"What is incredibly important here is how the U.S. consumer is going to behave," Rasche says. "The consumer has been the rock steady thing that has led us out of recessions."

One measure of consumer behavior is the personal savings rate -- if people are saving, they are not spending.

But Rasche suggests a better measure is household wealth -- which has been hammered by falling home prices, battered 401(k)s and declining stock prices (even after the recent nine-month market rally).

"Wealth, not income, is the fundamental driver of consumption demand," he says.

If the consumer doesn't lead us to a strong, sustained recovery, it's unlikely that state or local governments will. And the federal government -- which has already poured trillions of dollars into the economy -- is likely running out of bullets.

To that point, Rasche quotes Congressional Budget Office director D.W. Emmendorf:

"Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States. Over time, the accumulation of debt would seriously harm the economy.

"Alternatively, if spending grew as projected and taxes were raised in tandem, tax rates would have to reach levels never seen in the United States. High tax rates would slow the growth of the economy, making the spending burden harder to bear."

If the national outlook is concerning, Tennessee's outlook is downright frightening.

"We have been affected by the recession more than the average state, both in terms of the fiscal environment and in terms of employment losses," says William F. Fox, the William Stokely Distinguished Professor of Business and the director of the Center for Business and Economic Research at the University of Tennessee.

Fox, who followed Rasche with a presentation on the state outlook, says Tennessee has not seen year-over-year declines in tax revenues in modern times -- until 2008-2009. And he forecasts another decline in 2010.

"In 2011 we'll begin to see some growth in tax revenues but at a rate that is so modest that tax revenues will still sit $700 billion or $800 billion below their peak and it will be at least 2012 and likely 2013 before they get back to where they were in 2007.

"We're in real trouble in terms of long-term stability of government finance in Tennessee."

And the options are not promising: rely on federal stimulus (not much left), cut spending (most spending is on education and healthcare), raise taxes (politically infeasible) or drain reserves (very little to cut).

"We've essentially used all of the options, except rate increases and I don't hear anybody talking seriously about rate increases," he says. "At the other end of this (recession), what we'll have is a smaller state government.

"The next governor is going to have a very tough challenge figuring out how to finance this smaller government."