Issue of the week: Consumers run out of steam

Suddenly, Old Reliable doesn’t look so reliable anymore, said Justin Lahart and Kelly Evans in The Wall Street Journal. Until recently, consumer spending, which drives 70 percent of U.S. economic activity, managed to hold up in the face of falling real estate prices, higher energy costs, and rising unemployment. “But now, evidence is mounting that consumers are curbing their spending as they grapple with a growing load of debt.” Middle-market retailer Sears Holdings said sales at its stores fell 3.5 percent in November and December compared to the same months a year earlier. And it appears that even affluent consumers are feeling the economic pinch. Luxury jeweler Tiffany & Co., for instance, also said that its U.S. sales fell during the holidays. The downturn could be long-lasting, because consumers have little set aside for a rainy day. “Households are in terrible shape right now,” said Northern Trust economist Paul Kasriel. With many consumers unable or unwilling to tap the equity in their homes, “they don’t have any reserves to fall back on.” Kasriel sees a 65 percent probability of a recession this year.

That may actually be too optimistic, said Michael Barbaro and Louis Uchitelle in The New York Times. Consumer satisfaction with the economy has fallen to a 15-year low, according to the Pew Research Center. That kind of unease can really leave an economy reeling, as consumers change the way they live. New York City travel consultant Gia Trumpler, for instance, has started brown-bagging her lunch instead of eating out. “Everything just feels more expensive to me now,” she said. Such austerity doesn’t come easily to American shoppers. “Even in tough economic times, consumers rarely reduce their consumption.” But if enough people share Trumpler’s wariness, consumer spending could actually fall this year from the year before—the first time that has happened since 1991.

The cloudy spending outlook has increased the odds of a steep cut in interest rates, said Daniel Pimlott in the Financial Times. The Federal Reserve has already cut short-term rates by a full percentage point since last September, and the betting in the financial markets is that a further half-point cut is virtually assured. Indeed, some traders are betting that the Fed will opt for a three-quarter-point cut—the steepest reduction since 1982. But some economists think that would be an overreaction. “The data on retail sales is mildly disappointing,” said Thomson Financial economist Jeoff Hall, but “we are not in these dire economic straits.”

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Not yet, anyway, said James C. Cooper in BusinessWeek. But because of the credit crunch, if conditions worsen, the consequences could be severe. “A full-fledged contraction in economic activity” would “intensify the crunch by causing credit quality among businesses and consumers to deteriorate even more.” When the Fed’s policymaking committee meets on Jan. 30 to assess the economy and consider an interest rate cut, it will face “one very pointed question: Have its efforts to protect the economy from the credit turmoil that flared up last August been too little, too late?”