Economist David Backus writes:

A casual reader of economic news can’t help but get the impression that the way to get the economy moving is to have people spend more — consume more, in the language of macroeconomics. Seems obvious, doesn’t it? At the risk of making the obvious complicated, I’d say it’s not so obvious. It’s also not obvious that consumption has gone down since the crisis, or that saving has gone up. So what’s going on with the labor market?

I’ll get to the rest of the explanation, but first some background. The other day, I posted posted this remark from Backus:

This is from my area of work, macroeconomics. The suggestion here is that the economy is growing slowly because consumers aren’t spending money. But how do we know it’s not the reverse: that consumers are spending less because the economy isn’t doing well. As a teacher, I can tell you that it’s almost impossible to get students to understand that the first statement isn’t obviously true. What I’d call the demand-side story (more spending leads to more output) is everywhere, including this piece, from the usually reliable David Leonhardt.

Leonhardt responded:

We can’t know, for sure. But here’s an important clue: If a weak economy inexorably led to weak consumer spending, which in turn led to an even weaker economy, we would never escape recessions. We’d enter an inescapable spiral. You often hear warnings of such a cycle in the latter stages of a typical economic slump. Unemployment is high and even rising. Income growth trails inflation. Bankers and corporate executives are uncertain about when the recovery will begin.

Robert Barbera, an economist and author, will sometimes tick off this list of the grim realities in the late stages of a recovery and then conclude by bellowing, “And it was ever thus!”

His point is that recoveries are able to begin even when consumers seem to have little available money, and he’s absolutely right.

After the 2001 recession, the economy did not begin adding jobs until 2003 — but consumer spending was rising again by the end of 2001. Likewise, in the early 1990s, job gains did not start until the spring of 1992, but consumer spending began to recover in 1991. In 1982, consumer spending started to pick up speed in the summer, while the economy was still shedding hundreds of thousands of jobs.

How does this happen? Even before employers begin adding jobs again, the pent-up demand that exists in the late stages of a recession — for new cars, appliances, even vacations — asserts itself. People start shopping again.

The absence of this dynamic is what distinguishes the bursting of a bubble, like the one we’re experiencing now. There is not as much pent-up demand, because of the earlier bubble excesses. Even more important, consumers are not able to fulfill the pent-up demand they do have, because they are still paying down debts and trying to rebuild their finances.

Ultimately, this issue is not either/or. An improving job market would, of course, play a big role in lifting consumer spending and the economy. But I think it’s a mistake to view consumer spending as merely, or even predominantly, an effect of other economic changes.

Backus saw this but remained unconvinced. He writes:

This may be more macroeconomics than you’re looking for, but I’d say he ducks the issue. This sentence, for example: “If a weak economy inexorably led to weak consumer spending, which in turn led to an even weaker economy, we would never escape recessions.” Huh?

Leonhardt doesn’t mention this, but there’s another issue on this one: consumer spending isn’t falling, it’s rising.

Now here’s the rest of Backus’s story:

There are also some issues of fact that don’t fit the consumption bust story. Among them:

* The dollar value of consumption hasn’t dropped at all as a fraction of GDP. In fact, it’s at an all-time high. See line 2 of http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=14&Vi…

* Real consumption growth hasn’t dropped. It did the usual thing during the great recession: it fell less than GDP did, then the reverse on the rebound. I don’t see how you can look at this and see a collapse in consumer spending. See:
http://research.stlouisfed.org/fred2/graph/?g=19y

* Personal saving — in some ways the opposite of spending — has risen, as many have noted, but it looks to me like an oddity: the government’s saving has fallen enough to more than reverse this. To put it more clearly, today’s low tax revenues show up as high personal saving and low (negative) government saving. That’s not the kind of thing we have in mind when we talk about saving going up, and it’s likely to be temporary in any case.

* Household net worth (expressed as a ratio to GDP) shows at most a modest uptick in the recent past, so the increase in personal saving has yet to make a significant dent in household balance sheets: http://pages.stern.nyu.edu/~dbackus/CA/ms/fact_fiction_figures.pdf

* Where Leonhardt is exactly right is on durable goods spending (cars, appliances, furniture) and residential construction (new houses). See lines 4 and 12 of the first link. Those are relatively small
components of GDP, but there’s no question they’ve gone down and remain well below their pre-crisis levels. Housing I think we understand — we overdid it, and won’t need to add to the stock at the same rate as before. Cars I don’t know. Are people driving less? Driving older cars? Living in Manhattan, it’s hard to get a sense of
this, there still seem to be lots of yellow cars around.

Anyway, that’s food for thought. But if consumption isn’t the culprit behind the discouraging job picture, what is? We’re now planted firmly in the land of speculation, but here are a couple thoughts.

(i) Employment recovery has been slow coming out of every recession since 1990-91. Has the world changed? Hard to say, it certainly looks different from earlier periods. We also know from earlier
episodes that once recovery is well established, jobs will bounce back as well.

(ii) There’s more than the usual amount of uncertainty right now, so some firms may be waiting to see how things work out. We’d call it a real option: hold off hiring till we know that the recovery is here to stay.