Smith Faculty Opinion Article	March 31, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

Personal Income Up $31.5 Billion in February
Savings Improving but Negative, Yet Again

Today, the Commerce Department reported in February personal income increased $31.5 billion or 0.3 percent, disposable personal income increased $21.7 billion or 0.2 percent, and personal consumption expenditures increased $13.1 billion or 0.1 percent. The consensus forecasts were 0.4 percent for personal income and zero for personal consumption.

Significantly, personal outlays continue to exceed disposable income by $43.8 billion but the savings picture did improve. In January, personal outlays exceeded disposable income by $51.0 billion.

The modest increase in personal disposable income was still greater than the even more modest increase in spending, reducing the savings gap. The inevitable adjustment to positive savings may finally be beginning.

Housing prices have been falling since October, and the cooling housing market, along with slower personal income growth, is taking a bite out of consumer spending. Going forward, reduced growth in consumer spending will slow economic activity, and the job market will cool too.

This should raise a caution flag for the Federal Reserve but Chairman Ben Bernanke seems intent on pushing up interest rates and driving core inflation below 2 percent.

Outlook for Savings and the Stock Market

Household savings should improve regardless of Fed policy.

Over the past three years, consumers have been able to increase spending more rapidly than their incomes by borrowing against the rapidly rising values of their homes and piling on credit card debt. In recent months, stressed by higher gasoline and heating costs, most consumers have had few short-term options but to pony up. Now the string appears to be running out.

Since October, prices for existing homes have fallen and mortgage rates have risen, making home equity loans less obtainable and attractive.

No longer able to easily borrow against equity in their homes, consumers are making adjustments. New car demand will tilt more toward smaller vehicles, which are both less expensive and more fuel efficient. New homes will offer fewer amenities and perhaps less finished square footage too.

The combination of declining housing prices and higher interest will encourage consumers to rebuild their balance sheets and begin saving again. That will slow the economy.

Most economists expect the economy to accomplish a soft landing, with growth averaging about 3.3 percent in the second half.

A combination of moderate growth and more consumer savings will give the stock market a lift. As housing becomes a less attractive, ordinary investors will increasingly look to stocks for a long play.

Outlook for the Economy and Fed Policy

Consumer spending, which accounts for 70 percent of GDP, has been the primary driver behind the economic recovery the last four years. Recovering household savings indicate policymakers can no longer count on consumers to power growth. With the trade deficit near record levels, investment must pick up the slack but that is unlikely.

Commercial construction is likely to pick up, especially in and around cities powered by knowledge-based industries, finance, and durable goods manufacturers, which other than Ford, GM and their suppliers, are recovering.

Gains in commercial construction will be partly offset by a weaker housing sector. Investments in producer durables and technology will be decent but not spectacular.

Together, gains in construction, producer durables and technology spending will not be enough to offset the decline in consumer spending and keep the economy expanding at the pace established in 2004 and 2005.

The economy will post strong growth for the first quarter, which is partial compensation for weak fourth quarter growth. However, outlook is for slower growth by the third quarter.

The Fed wont see enough tangible evidence of slower growth until June. That is why most forecasters are banking on one or two more increases in the Federal Funds rate.

Also, recent consumer price data indicates inflation, less volatile food and energy prices, remains above 2 percent and above Federal Reserve Chairman Ben Bernankes comfort zone. Having to establish his credibility with financial markets, expect Mr. Bernanke to err on the side of caution, even if that risks slowing the economy too much and driving up unemployment.

Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.