As consumption goes, so goes the American economy

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Snapshot for March 19, 2008.

As consumption goes, so goes the American economy

by L. Josh Bivens

The latest (and perhaps late) U.S. economic recovery has been driven by an extraordinary boom in consumption spending. Between 1947 and 2000, personal consumption spending averaged 64% of total gross domestic product (GDP). Over the latest economic recovery (beginning in 2001), it has averaged 70%.

A return to the long-run trend of consumption spending is the most likely factor that could lead to a long and damaging recession. Given this, it is worth knowing what factors may have contributed to the recent consumption boom. A prime candidate is the growing importance of mortgage equity withdrawals (MEW) in recent years. As home prices soared and lending standards loosened, American households withdrew huge amounts of equity from their homes to support their purchasing power—a practice often short-handed as "using homes like an ATM."

The Chart plots consumption and mortgage equity withdrawals as a share of the economy. The story is pretty simple: the historic increase in mortgage equity withdrawals over the past 10 years coincided with the consumption boom. Now that falling home prices and tightening lending standards have squelched mortgage equity withdrawals, a drop in consumption spending may not be far behind; and, as consumption goes, so goes the American economy.