The main constraint on spending going forward will be the desire to beef up savings and reduce debt burdens. However, with layoffs slowing down, it is only a matter of time before the economy starts to generate positive job growth. While a larger portion of incomes will likely be deposited into savings accounts, it's hard to imagine the savings rate will increase dramatically from here. From its low point of under 1 percent in early 2008, the savings rate has risen to almost 5 percent over the past three months, which is actually a full percentage point above the average that prevailed between 1994 and 2008, although below the 7 percent average during the 1980s. We suspect that households will want to build up a larger cushion of savings to guard against possible adversity and to replace some of their wealth lost to the housing and stock market declines in 2008.
As people become more optimistic, personal spending may begin to improve. Also, the debt side of the household balance sheet is being rapidly brought down. Households started to seriously reduce debt burdens late last year, but their efforts have proceeded at an astonishing pace in recent months. In July, consumers paid down an unprecedented $21.6 billion more debt than they took out, following six consecutive monthly paydowns averaging $14.2 billion. At the end of the month, consumer debt stood 4.2 percent below the level of a year earlier. That's a swing of about 10 percentage points from the 5.2 percent average growth rate in consumer debt that fueled spending during 2007 and early 2008. Needless to say, the debt pullback has contributed significantly to the spending retrenchment that has since occurred. (See chart for details)
To be sure, not all of the debt paydowns reflect a newfound sense of frugality on the part of households. A good deal of it simply reflects tighter lending standards by risk-averse banks and other institutions striving to restore profitability. To this end, credit card rates have been lifted, stiffer fees have been imposed and credit limits have been lowered. But there is little question that households have greater access to credit now than was the case during the height of the credit crisis late last year and earlier this year.
Indeed, it may well be that the astonishing reduction in consumer debt this year has as much to do with banks writing off bad loans as it does with households paying off their obligations. As the chart shows, the rate of bank chargeoffs of consumer loans has surged over the past year, reflecting the heightened stress on households budgets amidst huge job losses during the recession. During the second quarter, nearly 10 percent of credit card debt was written off, the highest since records first began in 1985. That trend likely continued into the third quarter, and may have accounted for the lion's share of the record debt paydown in July. If so, that would explain why nonrevolving credit fell even as auto sales spiked under the cash for clunkers program.
