Smith Faculty Opinion Article	August 2, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

Personal Income up $67 Billion in June: Personal Savings Continues Negative and Stagflation and Recession Threaten

Today, the Commerce Department reported in June personal income increased $66.5 billion or 0.6 percent, disposable personal income increased $53.2 billion or 0.6 percent, and personal consumption expenditures increased $35.4 billion or 0.4 percent. My forecasts, published by Reuters, were 0.6 percent for personal income and 0.4 percent for personal consumption expenditures.

The price index for personal consumption expenditures, including food and energy, increased 0.2 percent in June and was up 3.5 percent from June 2005.

The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This index increased 0.2 percent in June and was up 2.4 percent from June 2005.

Clearly, core inflation remains above Federal Reserve Chairman Ben Bernanke's target range. Falling GDP growth and rising consumer prices indicate the economy may be headed for stagflation. Rising prices and slowing growth leave Bernanke with tough choices.

Significantly, personal outlays exceeded disposable income by $138.9 billion in June, and the savings picture continues worrisome. In May, personal outlays exceeded disposable income by $152.5 billion. The savings rate personal savings as a percentage of personal disposable income were minus 1.4, 1.6 and 1.5 percent in April, May and June, respectively. Savings have been negative for more than a year.

Although consumers continue to spend, gasoline and imported petroleum are taking a bigger bite. In May and June, retail sales less gasoline declined and sales of domestically produced autos were lower than in April. The combination of bigger payments for imported petroleum and sagging demand for U.S. made automobiles significantly reduces the demand for U.S. made goods and services from semiconductors to steel.

The slowing housing market and higher credit card rates should further break consumer spending. No one should be surprised that despite strong profits business investment is weak, and corporations are using profits to buy back shares rather than rapidly expand their U.S.-based enterprises. The U.S. market is just not expanding very rapidly, and with household savings negative for more than a year, consumer demand will continue to grow slowly.

Overall, rising petroleum prices, the flagging competitiveness of U.S. automakers and recent interest rate hikes are slowing the economy more than economic forecasters expected.

With savings so low, higher interest rates, especially mortgage rates, could easily cause an abrupt change in consumer behavior. A sharp increase in savings could throw the economy into recession.

The risk of recession is apparent. Now is the time to quit raising interest rates. Sometimes the best monetary policy is to do no harm.

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