Stimulus Boosted Incomes and Spending

Personal disposable incomes surged 11% after adjusting for inflation in January. Nearly all of that gain (96.3% by my calculation) can be attributed to a surge in stimulus checks and enhancements to unemployment benefits. Stimulus checks represented the lion’s share of those gains. After adjusting for those supplements and inflation, personal disposable incomes rose 0.2%, which is nothing to write home about given the weakness we saw in the fourth quarter and the risk for millions of falling off a cliff due to suspended unemployment benefits in January.

Personal consumption expenditures rose 2% after adjusting for inflation. That helped to reverse two months of declines. Gains were concentrated in spending on goods. Spending on everything from recreational goods and vehicles to food. There was a much smaller bounce in spending on services, notably food services and accommodations. Health care spending rose. The bias toward goods spending no doubt helped employment in those categories.

The saving rate surged back above 20%, the highest rate since May when the aid and stimulus from the CARES Act was helping to buoy saving. That saving played a key role in fueling a strong rebound in jobs in late spring and early summer and helped support spending even when unemployment benefits lapsed over the summer. We ran into more problems with food insecurity - hunger - and the threat of evictions as those funds disappeared during the fall and winter.

The moral of the story is that stimulus checks are extremely quick to hit consumer wallets, which is important in getting money to those who need it most. The problem is that they are not well targeted and cannot stimulate the areas hardest hit by the recession - discretionary services - until the economy can be more fully reopened. The next round of checks could have a bigger impact on bringing workers back to work if they are timed close to when social distancing measures can be lifted.

Separately, the PCE index rose 0.3% in January. That increased the year-over-year measure to 1.5%. The core PCE, which excludes food and energy, also rose 0.3% after rounding in January, and gained 1.5% from a year ago. Both measures of inflation revealed a modest acceleration but remained well below the Federal Reserve’s target of 2%. Goods inflation is outstripping service sector inflation. We expect those trends to reverse when pent-up demand in the service sector is unleashed this summer. We should see a sharp increase in year-over-year measures of inflation this spring, given the sharp deceleration in inflation we saw at the onset of the crisis a year ago.

The Fed will look past both of those increases as they are expected to be transitory. Any flare in inflation we see tied to the surge in demand from an easing in social distancing would have to show up as a sustained acceleration in wages to be persistent. That has not happened in four decades, which is why the Fed is skeptical it will happen today. Moreover, Fed officials believe they have ample room to correct course by raising rates to stem any persistent rise in inflation triggered by a more rapid return to full employment. Note: They now consider labor force participation rates and the impact that low unemployment has on a much broader spectrum of wages than they did in the past.

Bottom Line
The economy came close to crashing in the fourth quarter with a pullback in spending even on goods. The aid passed in late December played a key role in reversing those losses even as the pandemic continued to curb activity. The aid and stimulus are critical to bridging COVID-tainted waters, stemming employment losses in the goods sector and priming the pump for a more robust recovery once social distancing measures are lifted.

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