Some analysts are shocked that US retail sales have declined. Have they lost their grasp of basic economic concepts?he commerce department reported that retail sales in May were down by 1.2% from April. This surprised most economists who had expected a modest increase. The media were filled with accounts of economists trying to explain why consumers were still reluctant to open up their wallets and spend in a big way. It would have been much more interesting to hear accounts of why economists were surprised.
There is always a large random element in month-to-month movements in retail sales or any other economic variable. Therefore no one is ever going to be able to explain these changes with any precision. (The data are also subject to large revisions, so it is entirely possible that revised data will look very different from the report released last week (pdf).)
Nonetheless, there is little basis for the surprise shown by so many economic analysts. With few exceptions these analysts failed to see the $8tn housing bubble, the collapse of which sank the economy. Remarkably, even now they apparently cannot understand its importance.
To put it as simply as possible (so even an economist can understand it), the housing bubble was driving the economy in the period prior to its collapse, beginning in 2007. It drove the economy in two ways. The run up in house prices led to a building boom. Residential construction, which is typically less than 4% of GDP, rose to more than 6%, creating more than $300bn in additional annual demand. A bubble in non-residential real estate added perhaps another $150bn to annual demand.
The bubble also drove the economy through the effect of housing wealth on consumption. Economists usually estimate that $1 of additional housing wealth increases annual consumption by between 5-7 cents. This implies that the $8tn of housing bubble wealth would lead increase consumption by $400bn to $560bn a year.
With most of the bubble wealth eliminated by the collapse of house prices over the last three years, we should expect a sharp drop in consumption. Furthermore, stock prices have lost a bit less than a third of their value (around $6tn), which we should expect to cause a further decline in consumption. With the stock wealth effect estimated at 3-4 cents on the dollar, the decline in stock prices should have reduced annual consumption by $180bn to $240bn. In total we should expect to see annual consumption have dropped by between $600bn and $900bn as a result of the loss of housing and stock wealth.
This is all very simple arithmetic and basic economics.
More:
http://www.commondreams.org/view/2010/06/15-1
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