In February, Personal Income rose 0.3%, down from the 1.2% rise in January and a 0.5% increase in November. The increase was in line with the consensus expectation. Both January and December were revised higher. Previously the increase in December was thought to be 0.4% and for January 1.0%.
However, most of the increase was due to the 2.0% cut in the employee side of the payroll tax. Payroll taxes — and other contributions to social insurance — are counted as a subtraction from personal income, so if they fall, personal income rises. That was only partially offset by the end of the “making work pay” tax credit.
Meanwhile, Personal Consumption Expenditures (PCE) rose by 0.7%, higher than the consensus expectation of a 0.3% rise. That is an acceleration from the 0.3% rise in January and a rise of 0.4% in December. The December increase in spending was revised down from 0.5%, while January was revised up from 0.2%.
Of course, if spending is rising faster than income, it means that the savings rate is falling. It rose to 5.8% from 6.1% (revised from 5.8%). The savings rate is well above the dangerously low levels that prevailed from 2004 to 2008.
The graph below shows the long-term history of the savings rate (unfortunately not updated with the February data yet at the St. Louis Fed Database).
Over the long run, a higher savings rate is good for the country, and is desperately needed as the savings rate has been in more or less a constant secular decline for the last 30 years. Without domestic savings, we have to borrow from abroad to invest in the economy. Capital imports are the flip side of the trade deficit. If we sell less abroad than we buy, then we go into debt abroad. That is the same thing as importing capital.
The chronically low savings rate has left the country trillions of dollars in debt to the rest of the world. Note that in the 1960’s and 1970’s the savings rate was normally around 9 or 10%, and started a long secular decline after the 1982-83 recession.
Prior to the 1980’s, the U.S was the world’s largest creditor nation by a large margin. Now we are by far the world’s largest debtor. The fall in the savings rate, and the increase in our indebtedness, is not a coincidence — it is a causal relationship. The extraordinarily low savings rates in the five or six years leading up to the Great Recession were a disaster for the country, even though it made things seem good at the time. We are paying the price for that party now.
In the short run, on the other hand, a rising savings rate slows economic growth, and vice versa. If someone gets a raise but does not spend more, then that raise does not stimulate other economic activity. If the raise is not spent, then there is no increase in aggregate demand. It either increases future potential demand, or pays for demand that occurred in the past (i.e. debt is paid down).
On the other hand, if people are socking away less than they were for a rainy day, it increases current demand. If people go out to eat rather than stay home, it means that there is more work for waiters and cooks.
Will the Savings Rate Stabilize?
The question is, will the savings rate stabilize here? The desire of consumers to sit on their wallets and not spend their increases in income is very understandable. The collapse of housing prices destroyed trillions of dollars of wealth. That wealth people had been planning on using to finance their retirements or put the kids through college.
Housing wealth is (or at least was, when the country still had it) far more “democratic” than stock market wealth. Personal housing wealth does not form the basis for large plutocratic fortunes – it is the stuff of which more modest middle-class nest-eggs are made. Now that money has to be replenished the hard way, by spending less than you earn. Note how the savings rate tends to rise during recessions.
The very fact that more people decide to save is one of the reasons recessions are, well, recessionary. On an individual basis, being thrifty is a good thing, and so is paying down your debt. However, if everyone decides to do it at the same time, it is a very bad thing. This is what Lord Keynes called “The Paradox of Thrift”.
“The Paradox of Thrift” is the change in the savings rate, not the level that causes the pain. While the current decline in the savings rate is welcome for the short term, it is not healthy in the long run. We need more domestically formed capital, rather than relying on importing capital from abroad. Importing capital is the flip side of running a trade deficit.
The rise in the savings rate during the Great Recession was very rapid, and was one of the key reasons the recession was so severe. We are still a long way from the sort of savings rate we had back in the 1960’s and 1970’s, but we are a lot closer than we were a few years ago. Slowly people are making progress on repairing their balance sheets, but the damaged caused by the financial meltdown of 2008 and the resulting Great Recession was catastrophic. The process is being undermined by the resumed decline in housing prices.
Details Behind the Headline
The components of Personal Income are as important as is the total number. As I noted above, the unusually large jump in January was primarily due to the change in the payroll tax. In total, personal income rose by $38.1 billion, a big decline from the rise of $147.4 (revised from $133.2) billion in January (seasonally adjusted annual rates, as are all the subsequent numbers on the components of personal income). Since the reduction in the payroll tax is only for one year, this is not a particularly high quality source of personal income growth.
On the other hand, it is probably of higher quality than government transfer payments (for example Social Security and Unemployment Insurance benefits). Those fell by $1.1 billion in February after falling by $0.1 billion in January.
In January, private sector wages rose by $16.4 billion, down from a $16.7 billion increase in January. However, there was a big upward revision to the January number — they were originally reported as an increase of $14.8 billion.
Wages in the goods-producing sector fell by $1.0 billion in February, down sharply from a $12.0 billion increase in January. Offsetting that, wages in the private-service sector were up $17.4 billion versus an increase of $4.7 billion in January. Overall government wages rose by $0.3 billion after rising $2.5 billion in December.
Private wages and salaries are the most important, and highest quality, form of personal income. Government wages have to be paid out of either taxes or government deficits. Government workers do, however, spend their money in the private sector, just like private-sector workers do.
Proprietors Income
Another important source of personal income is proprietors’ income. In other words, what the self-employed and small businesses were earning. That increased by $2.5 billion in February, down from a $3.9 billion rise in January. Farm proprietors incomes rose by $0.5 billion, matching a $0.5 billion increase in January.
Strong commodities prices have led to a stunning increase in farm incomes. Farm proprietors’ incomes have risen every month since March of last year. The overall strength down on the farm helps explain why the Great Plains states like the Dakotas and Nebraska are weathering the downturn so much better than the rest of the country. It is also a good sign for firms that are tied to the farm economy, such as Deere (DE). Tractor Supply (TSCO) and Potash (POT). It also suggests that perhaps Willie Nelson needs to find a different recipient for his charity concerts.
Non-farm proprietors’ income rose by $2.5 billion, down from a $3.7 billion rise in January. In other words, what we normally think of as small business income is showing signs of getting back on track, but is hardly booming the way farm income is. Farm proprietors’ income is tiny relative to non-farm at just $58.0 billion versus $1.0366 trillion.
Since July 2010, non-farm proprietors income is up a nice, but hardly exciting 3.0%. Non-farm proprietors income actually peaked back in December of 2006 at $1.1129 trillion, so small business income is still 6.9% below peak levels. On they other hand, it bottomed out in May 2009 at $971.6 billion, so we are now 6.7% above the valley floor.
Other Forms of Income
Rental income rose by $8.3 billion in January, up from a $8.2 billion increase in January. Rental income has increased every month since November 2009. Given the still-weak condition of the real estate market, this is somewhat surprising, but a sign that it is slowly on the mend.
Capital income, or income from dividends and interest, rose by $7.7 billion after it rose by $8.8 billion in January. This income is particularly important to retirees. While interest rates are still very low by any historical measure, they have increased over the last few months, most notably longer term T-notes. Interest income fell by $1.0 billion in February, matching its January decline.
Dividend income rose by $8.6 billion on top of an $9.9 billion increase in January. Dividend income can be a bit erratic month to month, but the general trend seems to be upwards, since October total dividend income is up by 4.5%. The decision to allow most of the “too big to fail” banks to substantially increase their dividends means that dividend income is likely to continue rising nicely over the next few months. The decision was however, very ill advised from the point of view of banking system soundness and safety.
The final big component of personal income is government transfer payments. Like government salaries, this source of income has to come from either taxes or increased deficits and so it is a less desirable source of personal income from the point of view of the economy as a whole.
However, it is still income that gets spent in the economy. Wal-Mart (WMT) really doesn’t care if the money spent in its stores is from the elderly using their Social Security checks or the dividends they get from their investments, or really if it is retirees shopping there or people still in their working years spending their wages there, or their unemployment benefits. Transfer payments rose this month by $1.1 billion, after falling 0.1% in January.
Over the long-term, though, the economy cannot simply grow through ever-increasing amounts of money being handed out by the government. Those payments are very useful in the short run to help hold up overall consumer spending when the economy has turned soft. In the long run, the economy needs income from wages and salaries, and from small businesses earning profits. It is those earnings and profits that pay the taxes that support the transfer payments.
It is then worth looking at personal income excluding transfer payments, as shown in the second graph. Since it is a long-term graph, inflation plays a much bigger role over time, and the graph is based on real personal income rather than nominal (which the rest of the numbers in this post are based on).
Note that during most recessions (and the immediate aftermath) incomes excluding transfer payments flatten out, but do not fall significantly. The Great Recession was very different in that regard, with income ex-transfer payments falling by 6.67%, in real terms, between 12/07 and 10/09. We are now starting to see a very tentative recovery in it, up 3.69% from the 10/09 low.
Positive Report
Overall, I would have to rate this report as positive. Income was up as expected, the overall quality solid. January was sort of a special case, the biggest factor by far was the cut in the payroll tax, and that will go away next year. Transfer payments rose by a modest $1.1 billion, after actually posting a slight decline in January.
The declining support from transfer payments is fairly significant if one takes a step back. The February increase in transfer payments was just 2.9% of the overall increase in Personal Income. For all of 2010, total personal income rose by $371.8 billion, of which $163.8 billion, or 44.0% came from increases in transfer payments. The quality of the income growth has improved significantly. The biggest positive to the report, though, were the upward revisions to both December and January.
Aside from the payroll tax effect, the increase in personal income so far this year is coming from sustainable sources like higher wages and salaries, most notably from the private sector, and from higher proprietors incomes. In other words, small businesses are starting to do better, even non-farm small businesses.
Growth in dividend income is likely to continue as firms share their strong earnings growth with their shareholders. It should get a big boost in the next few months due to the increased dividends that the recently bailed out banks are going to be paying. The fall in the savings rate is bad over the long term, but is helpful right now in getting the economy back up closer to potential.
On the spending side, the report was also positive, rising 0.7%, which was a nice acceleration from the 0.3% rise in January. It was also well above the 0.5% rise that was expected. Revisions were sort of a wash, but 0.1% for January, but down 0.1% for December.
The composition of the increase was also better than in January. Of the total $69.1 billion increase in spending, $18.7 billion of it went to durable goods, and spending on services rose by $15.9 billion. Spending on non-durable goods, such as food and gasoline, was up by $34.5 billion. In January, not only was the total increase much smaller at $28.1 billion, but virtually all of it ($24.6 billion or 87.5%) went to non-durable goods.
Since overall demand for things like food and gasoline tends to be stable, it suggests that that increase was being driven by higher prices in January. Spending on non-durables like gasoline does not indicate the same sort of consumer confidence that spending on durable goods like cars does. Spending on services rose by $15.9 billion, up from an increase of just $1.4 billion in January.
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