Consumer spending is back, thanks to services

Economic indicators have been improving, albeit slowly, since the summer of 2009, confirming that the economy is on the mend. However, most observers likely would agree that full recovery — a return to pre-recession activity levels — won't happen anytime soon. But one key component of the economy — consumer spending — has made a full recovery and is now at an all-time record high.

Economic indicators have been improving, albeit slowly, since the summer of 2009, confirming that the economy is on the mend. However, most observers likely would agree that full recovery — a return to pre-recession activity levels — won't happen anytime soon.

For example, industrial production has increased since a low point in mid-2009, but April's reading was still only 91 percent of December's peak in 2007 when the recession began. Although payroll employment has gained each month this year, the current level remains 7.8 million jobs below the pre-recession peak.

But one key component of the economy — consumer spending — has made a full recovery and is now at an all-time record high. The U.S. Bureau of Economic Analysis estimates that real consumer expenditures (seasonally adjusted at annual rates) in the first quarter of 2010 surpassed the 2007 Q4 level by $9.1 billion.

Service spending at record high

It was the inexorable penchant for services that drove consumer spending to new highs. Service expenditures in 2010 Q1 were up by $82.7 billion, also a new record. In fact, service spending slowed but never fell below the 2007 Q4 level throughout the recession. Spending on durable goods, in contrast, dipped by 12 percent to a low point in mid-2009.

Combined nondurable and durable goods spending is still 2.7 percent or $75 billion below pre-recession levels (see table). While overall GDP is now at 99 percent of the post-recession peak, several components are 20 to 30 percent points away from full recovery.

Weakest of all is expenditures on residential building, at 67.2 percent of the 2007 Q4 level. However, unlike most other indicators, residential spending peaked much earlier, at $783.5 billion in 2005 Q3. The 2010 Q1 level is a bare 45 percent of that 2005 peak.

Overall private investment spending by business is 21 percent below the pre-recession level. Spending on equipment and software is at 85.2 percent of the pre-recession level, while nonresidential building is 25 percent below the level.

Federal government spending, bolstered by the stimulus program and still-growing defense outlays, is now up by 13.2 percent over the 2007 Q4 level. However, state and local government spending has not grown, and according to the latest macro forecast will continue to decline in 2010.

Macro forecast improves

Largely because of the rebound in consumer spending, the current forecast for GDP growth in 2010 has increased this month to 3.5 percent. Double-digit growth is expected this year in equipment and software spending, as businesses decide to part with some of their accumulated cash holdings (estimated at $2.8 trillion for nonfinancial firms). In spite of a stronger dollar and clouds on the European economic horizon, exports are projected to increase by 10 percent.