The American Consumer - Consumer Spending, Job Creation, And Interest Rates

Consumer spending is essential to economic growth in America, and is greatly affected by two things: employment and interest rates, which are interdependent factors in the economy. Historically, when interest rates have been lower, people have spent more, which has in turn stimulated the job market. And when people have steady and dependable work, they are more likely to spend money, which also adds jobs to the economy.

The Role of Consumer Spending in Job Growth

Figure 7.4 indicates that when people spend money, more jobs are created in all sectors of the economy. According to Mitra Toossi, an economist in the Bureau of Labor Statistics' Office of Occupational Statistics and Employment Projections, employment generated by consumer spending in the year 2000 was 83.2 million—accounting for 62% of total employment in that year—with consumer spending projected to add another 11.3 million net new jobs by 2010 ("Consumer Spending: An Engine for U.S. Job Growth," Monthly Labor Review, November 2002). Annually, the growth rate of employment in the decade from 2000 to 2010 is expected to be about 1.3%, which is considered much lower than the annual employment growth rate of 1.8% in the decade from 1990 to 2000.

Consumer buying choices can also stimulate—and even shift—job growth among industries. The higher the demand is for certain products and services, the more growth those industries will experience. The goods and services that are purchased by the consumer are called final goods; those that are used in the production of final goods are called intermediate goods. Demand for both final and intermediate goods leads to expansion in their respective industries, which in turn adds jobs to the economy. Consumer-driven job growth in the service sector is expected to outpace growth in the manufacturing sector until at least 2010, with manufacturing projected to lose about 440,000 jobs between 2000 and 2010. The service sector, on the other hand, is expected to add jobs because of consumer demand, particularly in the fields of business services (which include services such as advertising, leasing and rental, and data processing); health services; social services (such as day care and elder care); communications; transportation; wholesale and retail trade; and finance, insurance, and real estate.

Interest Rates and Spending

Interest rates are determined by the Federal Reserve Board (commonly known as the Fed), which is the central bank of the United States. The Federal Reserve sets the federal funds rate (the interest rate banks charge for overnight loans to each other), which then influences the prime rate

FIGURE 7.4

(the rate that banks charge their best customers; the prime rate usually is set at about three percentage points above the federal funds rate). From there, creditors set competitive rates for lending money to consumers. When interest rates are high, consumer spending, particularly for high-priced items such as cars and houses, tends to slow down because the cost of borrowing money is higher. Lower interest rates stimulate the economy because consumers can afford to borrow more at lower rates.

For example, the historically low interest rates of the early 2000s led to a high number of mortgage refinancings, which gave homeowners more money to spend monthly as their mortgage payments were lowered. Because of lower interest rates, many homeowners also had access to a source of disposable income unrelated to their wages: their homes. In 2003 American homeowners took advantage of rising property values and low interest rates by withdrawing $200 billion in equity from their homes. (Equity is the proportion of a house's mortgage value that a homeowner has paid off and actually owns; when a person gets a home equity loan, they have access to that part of their home's value in the form of credit, which they must then pay back.) In this sense, low interest rates are not always good for individual finances or the economy, since they lead to more debt in the form of home equity loans, car loans, and more credit cards. Economists warn that increased spending without a simultaneous increase in the number of well-paying jobs—an estimated 300,000 new jobs a month are needed—cannot sustain the economy (Louis Uchitelle, "Why Americans Must Keep Spending," New York Times, December 1, 2003).