The Dangers Of A Sluggish Household Spending Rate

Fri, 29 Jul 2016  |  

This article first appeared at the Adelaide Review website at this address: https://adelaidereview.com.au/opinion/business-finance-opinion/dangers-sluggish-household-spending-rate/#.V5k-QyDuwq8.twitter 

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The Dangers Of A Sluggish Household Spending Rate

One of the disappointing aspects of the performance of the economy over the past few years has been the moderate and frankly unimpressive rate of growth in household spending.

To be sure, households are continuing to increase their purchases of goods and services, but the growth rate of that extra spending has been mediocre and is one reason why the overall economy is muddling along rather than registering stronger job-creating growth. The reasons for this sluggishness in spending have several causes all of which are important.

Recall that households need funds or access to money to be able to spend. In its most simple form, they can use their income, run down savings or they can increase their borrowing to fund extra spending. Indeed, there are no other sources of funds by which to lift spending.

In terms of incomes, which is the dominant aspect of funds for consumer spending, the recent news has been particularly disconcerting. Wages growth has fallen to its lowest level on record with annual increases of just 2.1 percent in the March quarter. For the last 20 years, annual wages growth has generally been almost double that, averaging between 3.5 and four percent. With inflation averaging 2.5 percent, households usually had more cash at hand at the end of each year to spend.

Now, with inflation forecast to hover around two percent for the next few years, wages growth is not sufficient to free-up cash to underpin the much needed extra growth in spending.

In simple terms, the current weakness in wages growth is holding back the household sector’s ability to ramp up their spending to a higher level.

Household savings are also important. Since the Global Financial Crisis, Australians have had a strong inclination to save a significant part of their income. Looking back on the period from 2002 through to 2006, there were significant periods when the household saving ratio was negative. This meant that households were continuously spending more than they were earning and household consumption was strong as a result.

Would increased wages see a higher consumer spend?

Since the GFC, the saving ratio has averaged just below 10 percent, which means that household spending is 10 percent lower than their income. This replenishment of savings, in concert with record low wages growth, goes a long way to explaining the generally soft tone to household spending in recent years.

The other source of funds for spending is debt. Households can (and do) borrow money to fund spending, and this continues to be a significant source of funds used to support spending. While the bulk of new borrowing is directed at the purchase of dwellings, it does also filter through to consumer spending.

One thing that is difficult to be sure about is consumer sentiment and its influence on spending. There is usually a solid correlation between consumer optimism about personal finances and growth in household spending. In other words, when consumers are upbeat or optimistic, there is a strong tendency for spending to be high and vice versa.

At the moment, consumer-sentiment measures are broadly around their long-term trend, so, like the other indicators, there is no solid momentum for spending to pick up or slow.

While much of the focus on the recent performance of the economy has honed in on the slump in mining investment and weak commodity prices, it will be a change in the growth momentum of household spending that will determine whether the Australian economy weakens or gains some upside momentum into 2017.

What is a concern, and increases the risk of the weaker path unfolding, is the sluggishness in wages growth. The tendency of consumers to save 10 percent of their incomes and the likelihood that household debt is close to reaching its upper limits, there is a real risk that household spending growth will not only remain sluggish, but could weaken. If it does, the Australian economy will be in trouble.

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