August 01, 2006
Record Household Deficit - Is There Anything Wrong With This Picture?
by Paul Kasriel
With the release of the second-quarter advance GDP data and the revisions to 2003 through 2005 data, we can update our household surplus/deficit chart. Based on first-half data, it looks as though households are on course to run yet another record deficit in 2006. To refresh your memory, we subtract from disposable personal income (after-tax income) the sum of expenditures on consumer goods/services and residential investment (value-added in housing). If households' total expenditures are less than their after-tax income, then they are, in effect, running a surplus. This implies that they are advancing funds to other sectors - businesses, governments and/or foreign entities. If households' total expenditures are more than their after-tax income, then they are running a deficit. This implies that they are borrowing from or selling assets to other sectors. In the first quarter of this year, households ran an annualized deficit of $566.2 billion. In the second quarter, this annualized deficit increased to $588.0 billion. Based on this first-half data, households are on course to run a 2006 deficit of $577.1 billion, which would break the 2005 deficit record of $476.7 billion (see chart below).
Household Surplus (+) or Deficit (-)*Bil.$
* disposable personal income minus sum of expenditures
on consumer goods/service and residential investment
Assuming that households do, in fact, run a deficit for all of 2006, this would mark only the thirteenth time since 1929 that this has happened. Two years in which households ran a deficit were in 1932 and 1933 - the depths of the Great Depression. It is not hard to figure out why they might have run deficits then. With unemployment soaring, folks were selling assets and borrowing just to exist. Households again ran deficits in 1947, 1949 and 1950. Again, it is not too difficult to explain deficits in these years. During WWII, durable consumer goods and new houses were not available given that most production was being used for the war effort. And because there was not much to purchase for those working on the home-front during the war, they ran huge relative surpluses, to a large degree, in the form of war bonds. Soon after the end of WWII, with their balance sheets overflowing with assets relative to liabilities, households went on spending spree, buying houses, furniture, appliances and other consumer durables - hence the household deficits. Why households ran a deficit in 1955 is a mystery to me other than that was the year we bought the white-on-turquoise V-8 Ford.
This brings us to the "modern" era. With the exception of 2000, households have racking up large deficits starting in 1999. By the way, these deficits are not just records in absolute terms, but relative to their disposable incomes as well - e.g., 6.15% of disposable income in the first half of 2006. These "modern era" household deficits also are not that difficult to explain. Generational low nominal and real interest rates, in part engineered by the Fed, have had the effect of inflating the prices of assets - equities in the second half of the 1990s and houses in the first half of 2000s. Why should households spend less than their after-tax incomes when the value of their assets is skyrocketing? And, of course, with asset prices inflating, there is all the more collateral upon which creditors can advance loans. So long as asset inflation continues, we guess households can continue to run record deficits. We can't wait to see how the adjustment works out when the asset-price music stops.