South-Western College Publishing - Economics  
A Reversal of Spending May Be Fortunate
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Productivity, Inflation, Economic Growth
News Story

After months during which consumer spending exceeded gains in personal income, last month's data apparently revealed a turnaround in consumer behavior. According to the Department of Commerce, personal income increased by 0.7 percent in March, while consumer spending increased just 0.5 percent. As a result, the savings rate increased to 0.4 percent after falling to 0.2 percent in February, a record low.

The Federal Reserve has worried that consumers, with purchasing power inflated by stock-market gains, were spending beyond their income levels and creating inflationary pressure by pushing aggregate demand beyond long-run aggregate supply. Despite the turbulence in the stock market, consumer confidence is still very high and the University of Michigan's latest report indicates their measure of consumer confidence rose in April. The Federal Reserve has boosted interest rates five times since last June in an effort to reduce spending and slow the economy. The Federal Reserve may view the Commerce Department's report that spending in comparison to consumer income growth had slowed as a sign that the rate hikes have had some impact.

Real consumer spending, adjusted for inflation, increased by 0.1 percent after climbing 1 percent in February. A 2.4 percent decrease in durable goods accounted for most of the March decline. Many analysts doubt that this decrease will be sufficient to convince the Federal Reserve and its chairman, Alan Greenspan, that aggregate demand has moderated to the point that inflationary pressures are no longer a problem. Some of these analysts predict at least three more rate increases.

(Updated June 1, 2000)

Questions
1. How is personal income defined? How is it measured?
2. What is the relationship between personal income and aggregate demand? What impact does an increase in personal income have on aggregate demand? What impact does an increase in personal wealth have on aggregate demand?
3. How do interest rate hikes reduce aggregate demand?
Source Yochi J. Dreazen, "Personal Income Rose More Rapidly In March Than Consumer Spending," The Wall Street Journal, May 1, 2000.

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