Income declined as inflation remained robust in July

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By David M. Dickson

Consumer spending increased in July, but prices increased even more, suggesting that the growth rate of consumption, the linchpin of the U.S. economy that accounts for more than 70 percent of gross domestic product (GDP), may be turning negative in the third quarter. In fact, July was the second consecutive month that real (price-adjusted) consumer spending declined, the Commerce Department reported Friday.

After adjusting for inflation, real personal spending declined by a seasonally adjusted annual rate of 0.4 percent in July, following a decline of 0.1 percent in June.

Policymakers hoped the economic stimulus package of tax rebates, which Congress and President Bush approved early this year, would substantially increase personal spending as the economy slowed considerably during the fourth quarter of 2007 and this year's first quarter. Tax rebates are expected to total $106.7 billion during fiscal year 2008, which ends Sept. 30. Through last month, the federal government issued rebate checks totaling $1.9 billion in April, $48.1 billion in May, $27.9 billion in June and $13.7 billion in July.

In spite of the rapid dispersal of the economic stimulus payments in the April to July period, consumers pulled back on real spending in both June and July in the face of weak employment conditions, higher energy prices and further declines in household net worth, said Brian Bethune, chief U.S. financial economist for Global Insight.

A large share of the economic stimulus rebates wound up in personal savings accounts in the second quarter, Mr. Bethune said. Indeed, personal savings increased from an average annual rate of $21 billion during the January-April period to $317 billion during the May-July period.

July's sluggish spending numbers indicate that consumers are reluctant to tap into those accounts under current economic conditions, Mr. Bethune said.

Personal income, before adjusting for inflation, declined by 0.7 percent in July. Consumer prices increased a worrisome 0.6 percent in July after jumping 0.7 percent in June.

Personal income after taxes, or disposable personal income, declined 1.1 percent in July following a 1.9 percent decline in June. After adjusting for inflation, these annualized declines increased to 2.6 percent in June and 1.7 percent in July.

The July price-adjusted declines in personal income and personal spending indicate that the economy has slowed down from its unexpectedly swift pace of expansion during the second quarter. On Thursday, the Commerce Department revised the rate of economic growth during the second quarter from a previously reported 1.9 percent to a surprisingly robust 3.3 percent.

Not only did price-adjusted income and spending decline in July, but the 12-month rate of inflation accelerated. The 12-month rate of change in prices for personal consumption expenditures (PCE) jumped from 4 percent in June to 4.5 percent in July. Excluding food and energy, the 12-month core PCE price index, which measures the economy's underlying inflationary pressures, increased from 2.3 percent in June to 2.4 percent in July.

The PCE price gauges are the Federal Reserve's preferred measures of inflation. Ideally, the Fed wants to keep the core PCE price index between 1.5 percent and 2 percent. The core PCE index is now comfortably above the Fed's so-called comfort zone.

With the bulk of the rebate checks having been issued during the second quarter, consumer spending during the April-June period increased at annual rate of 1.7 percent. Economists expect consumers will be hard-pressed to maintain that rate during the current quarter. In recent months, inflation has roared ahead of nominal wage gains, reducing workers' purchasing power. While the recent decline in energy prices should reduce inflationary pressures in the future, consumers will be further constrained by ongoing declines in home values and falling employment levels, which declined during each of the first seven months of 2008.