Thursday, April 30, 2009

Is The Savings Rate Rising Or Falling?

Considering that headline GDP contracted at an annual rate of more than 6% both in Q4 2008 and in Q1 2009, real disposable income has held up surprisingly well. Indeed, it rose by an annual rate of 4.8% between September 2008 and March 2009. But how could real disposable income increase at an annual rate of nearly 5% when real GDP contracts at an annual rate of more than 6%?

Part of it reflects that they are deflated by different price indexes. Real GDP is derived using the GDP prices index while real disposable income is derived using the PCE deflator. Because America's terms of trade has improved dramatically due to a lower price of oil and because the GDP deflator is not adjusted for terms of trade improvements while the PCE deflator is adjusted for that, the GDP deflator has shown more inflation/less deflation which when deflating a nominal number means that real GDP will be a lot weaker than real disposable income.

But that is not the entire explanation. Even when adjusted for terms of trade, real GDP is still significantly down, while again real disposable income is strongly up.

So why the discrepancy? This can be explained by the specifics of disposable personal income. Between September 2008 and March 2009, nominal personal income rose 0.9%. Private sector wage and salary disbursements fell 2.7%, "proprietors income" (essentially small business income) fell 3.2%, income from assets (interest and dividends) fell 8%. The statistical construct called "rental income of persons" rose significantly, but that's a very small post so it had little overall impact and it is not really an income in the strict sense of the word (more like a cost saving for home owners).

The reason why disposable income rose despite these significant declines in market based income was that cash flow from government improved dramatically. Government wage and salary disbursements rose 2.1% and transfer payments receipts (with unemployment benefits increasing particularly much) rose 5.6%. Meanwhile, even as people are receiving more and more from government, they are paying less and less to it. Personal tax payments nearly collapsed, falling 16.5% while "contributions for government social insurance" fell 1.1%.

(Note that the numbers in the two above paragraphs aren't annualized).

Hadn't it been for the dramatically improved cash flow from government, then real disposable income would have fallen too. It should also be noted that while dividend income have been reduced, it hasn't fallen anywhere near as much as corporate earnings. Meaning that the implicit income that retained earnings constitute has fallen dramatically and if that had been factored in as well, real income would have fallen even more.

One obvious implication of the above is that real disposable income is misleading as an indicator of economic growth. Another, perhaps not immediately obvious implication, is that even though the official household savings rate has risen from 1.4% in September 2008 to 4.2% in March 2009, overall savings has in fact fallen dramatically because of the dramatic increase in the government deficit and the dramatic decline in corporate retained earnings.


Blogger Celal Birader said...

Hello Stefan ,

THIS article speaks of a resurgence of consumer spending.

I don't know how the Commerce Department calculates these things; but, i am wondering if this unexpected "rise" in consumer spending might have something to do with the "rise" in disposable income ?

5:11 PM  
Blogger stefankarlsson said...

Yes, Celal, it did. In a world where Ricardian equivalence holds true fully it wouldn't have been relevant, but since it doesn't, the artificial increase in disposable income did boost consumer spending.

5:36 PM  
Blogger Celal Birader said...

HERE is a different but somewhat related take on the recent GDP report : I don't know whether the subtaction of imports counteracts the effect of the GDP deflator but it seems to me this is also something else to think about.

8:33 PM  

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