The Straight Dope: Why Low Interest Rates Won’t Magically Stimulate the Economy

by Wall Street Daily
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The economy’s still sucking wind after enduring the Great Recession. So much so, the Federal Reserve announced yet another round of Quantitative Easing (Q3) last Thursday.

What’s up with all the money printing? The idea is that putting more money into circulation will encourage more consumption. And voila! Since the almighty consumer accounts for 70% of U.S. economic activity, a boost in consumption promises to kick start the economy.

The only problem? Consumer spending does not account for 70% of U.S. GDP.

I know. You’ve been constantly told that the consumer is, indeed, the biggest driver of economic growth. Heck, in the last month alone, 798 news outlets repeated it as gospel truth. Many upstanding and respectable ones, too.

Like USA Today in an article posted in late August: “Consumer confidence is widely watched because consumer spending accounts for 70% of U.S. economic activity.”

Or MarketWatch.com in a featured article around the same time: “Consumer spending accounts for as much as 70% of U.S. economic activity, but people tend to spend less when they are worried about the future.”

Sorry, folks. But this bit about the supreme importance of consumer spending is a total canard. And in honor of Myth Busting Monday in the Wall Street Daily Nation, I’m going to prove it…

Give Me Sloppy Joes, Not Sloppy Math

Sloppy (and lazy) math gets credit for this whopper.

You see, countless pundits and economists simply take the data from one category of GDP – personal consumption expenditures (PCE) – from the U.S. Bureau of Economic Analysis. Then they divide it by total GDP.

Doing so for every quarter since 2009, results in an average contribution of 70.8%.

Now, I’m not a conspiracy theorist by any stretch. But I don’t accept statistics at face value, especially from the government. So I actually took the time to find out exactly what’s included in this PCE category.

Guess what? Although PCE sounds like it should just include the money people like you and me spend on consumption, it involves a lot more than that…

Like Government Spending…

Don’t ask me why, but the $2.1 trillion figure attributed to healthcare spending in the PCE calculation includes government spending on Medicaid and Medicare. It also includes money spent by businesses for health insurance plans. Obviously, consumers have no control over this spending.

Consumers’ “out-of-pocket” healthcare expenses only total about $320 billion or 2.1% of GDP. The result? The healthcare component of PCE is overstated by 12.1 percentage points.

If we adjust the 70.8% calculated above accordingly, the consumer now only accounts for 58.6% of GDP. And we’re just getting started…

A Catch-All for Greenpeace, Too

Again, don’t ask why. I’m just reporting the facts. And the fact is, PCE includes operating expenses for religious organizations, political parties and social advocacy groups. The total amount? About $300 billion – or 2% of GDP.

Clearly, individuals have zero control over this spending, either. So let’s back it out. When we do, we’re down to consumers only accounting for 56.6% of GDP.

But wait. There’s more…

Funny Money

The wizards on Wall Street aren’t the only ones with accounting tricks up their sleeves.

The government’s PCE calculation includes imputed services, which account for $1.5 trillion, or 10% of GDP. Two of the biggest components are the imputed “rental value of owner-occupied housing and a value to services that banks and other depository institutions provide without charge.”

What’s the matter? You don’t understand government gibberish? Let me translate: This is money we pay to live in our own homes. And money we “pay” banks for services like free checking.

Last time I checked, I didn’t have a choice to pay myself less for my house. And I’m not exactly sure how one pays for services provided for free.

If you understand basic accounting, imputed services boil down to nothing more than the government balancing its books. In this case, it’s doing so by assigning values to economic activities where no money actually changes hands and consumers have no control over.

After backing out this segment, the consumer now only accounts for 46.6% of GDP.

News Flash: Not Everything is Made in America

I’m all for being patriotic. But let’s face the facts. When we buy $1 worth of clothes, electronics, cars, even gasoline, every penny doesn’t go back into the domestic economy. Why? Because not everything is made in America. Yet, somehow, these purchases are rolled into the PCE calculation, too.

Imported goods amount to roughly $2.3 trillion, or 14.8% of GDP. Let’s be conservative and say that 75% of the money we spend on imports (about $2.3 trillion, or 14.8% of GDP) ends up back in the domestic economy. The other 25% is going to stimulate economic activity overseas. And if we back out that component, consumer spending only accounts for 42.2% of GDP.

Bottom line: The importance of consumer spending on economic activity has been grossly exaggerated. Instead of accounting for 70% of GDP, actual household spending accounts for no more than 45% of GDP.

As Michael Mandel, Chief Economic Strategist at the Progressive Policy Institute, says, “That’s still large – but the U.S. is nowhere near as dependent on consumer spending as people think.”

No, it’s not. So consider this myth busted! And take note, even if QE3 reinvigorates consumer spending, it won’t magically cure all our economic woes.

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