Smith Faculty Opinion Article	October 3, 2006
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Personal Income up $38.4 Billion in August:
Falling Gasoline Prices Offer Hope for Holiday Sales

Today, the Commerce Department reported in August personal income increased $38.4 billion or 0.3 percent, disposable personal income increased $38.8 billion or 0.4 percent, and personal consumption expenditures increased $10.5 billion or 0.1 percent.

Adjusting for inflation, personal consumption expenditures declined 0.1 percent, indicating the economy may have contracted in August. Overall, August and September may prove the low point for the economic slowdown.

The price index for personal consumption expenditures, including food and energy, increased 0.2 percent in August and was up 3.2 percent from August 2005.

The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This core price index increased 0.2 percent in August, as compared to 0.1 percent in July. In August, the index was up 2.5 percent from August 2005.

The significant August increase in core inflation should not be viewed as predictive for the final months of 2006. August inflation reflected the residual effects of first half oil price increases, and these may continue to work through the system through September. However, with energy prices falling since mid-August, both overall and core inflation will head south during the final months of 2006.

Outlook for Federal Reserve Policy

Slower growth and rising consumer prices will leave Ben Bernanke with tough choices. Moderating oil prices and slower employment growth will temper inflationary pressures but that process may take another month or so. Pressures within the Federal Reserve policymaking apparatus may mount to further increases interest rates, but more tightening will affect commodity and labor markets with too much lag and only risk turning the slowdown into a recession.

Eventually, slowing growth will refocus Federal Reserve policymakers. Ben Bernanke will have to grapple with the potential for the housing market to panic in areas where realtor optimism cultivated irrational pricing, like parts of San Diego, Washington and New York, and where tough structural adjustments besiege local economics, like Detroit.

To keep the economy growing, Ben Bernanke may have to risk loosening monetary sooner than conservative elements within the Federal Reserve policymaking apparatus, or among pedestrian academics and policy wonks, would recommend.

Business cycles have shortened and external forces are now more important to the globalized U.S. economy. Steering the economy safely requires anticipatory, deft maneuvers a grand prix driver not a cruise ship captain. Such risk taking may not win the approval of hide-bound Ivy Leaguers or New York and Washington Federal Reserve watchers; however, by halting rate increases in August despite colleague haranguing, Ben Bernanke has already demonstrated why he has the office on Constitution Avenue, while some of his friends still doodle on blackboards or scribble on newsprint.

Household Savings

The savings picture improved, as the savings rate increased from negative 0.7 percent in July to negative 0.5 percent in August. However the situation remains worrisome. The savings rate personal savings as a percentage of personal disposable income was minus 0.4, 0.4, 0.7, 0.6, 0.7, and 0.5 percent in March, April, May, June, July, and August, respectively.

Savings have been negative for more than a year.

Although consumers continued to spend in August, imported petroleum took a bigger bite, and Americans are buying more foreign cars instead of American trucks. These purchases reduced the demand for U.S. made goods and services from steel to software to salsa.

The downsizing of General Motors and Ford is a terrible drag on the economy. A greater share of the foreign nameplates sold in the United States is assembled in Asia and Europe. Even when vehicles bearing foreign nameplates are assembled in the United States, they are made with fewer U.S. components and labor than U.S. brands. The workers employed in transplant factories earn lower wages and receive fewer benefits than those employed at GM, Ford and Chrysler.

The slowing housing market also affected consumer optimism in August and slowed spending.

Overall the second and third quarters may well prove the low point of the current economic cycle.

Going forward falling gasoline prices are putting more spendable income in American pockets, and housing values are still up about 50 percent over the last five years. Even with a moderate pullback in the housing market, Americans are much wealthier than they were two and five years ago.

The key question is: Will Americans focus on the recent modest decline in home prices and save more, or on the longer term gains they have enjoyed and are likely to sustain?

If consumers focus on the recent decline in home prices, savings performance will improve and economic growth could slow to 2 percent or less.

If consumers focus on their longer-term housing gains, they will keep on spending and holiday sales will ring bells of celebration, corporate profits will brighten and Wall Street will ride bulls into the New Year.

My bet is the falling gasoline prices prove the youth elixir for an aging economic expansion. The lion still has life, and 2007 will confound the forecasters with spring growth and colorful blossoms of prosperity.

If there is a God in heaven, GM and Ford may even manage to do better.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.