Credit Cards, Spending, Saving and the Larger Economy

A couple of articles caught my attention today. I think they have some applications for both the traditional economics and personal finance course. Let me provide the links and my thoughts and see if you agree or disagree.

The first article (free at this writing) was in today's edition of The Wall Street Journal. The focus of the story was the falling level of consumer credit. According to the story, consumer credit (includes credit cards and auto loans) has fallen for six months and some were expecting a seventh when the data was released today by the Federal Reserve. (They weren't disappointed.)

The data has some implications. And as is often the case in economics, a "one-armed economist" can't explain them. On the plus side, there are benefits to lower debt loads and cutting down on outstanding balances. On the negative side, trimmed credit spending leads into things like predictions of weak holiday sales, and increased pressure on many retailers at point when many were hoping to see a turnaround in the economy.

A confirming story was in The Washington Post. That article indicates that when we use cards, many of us are increasingly using debit instead of credit.

Anxiety about jobs and the general economic condition are making people more reluctant to "charge it". That means they have the means to pay for something or they do without. And items that exhibit high price elasticity, that can be a problem.

So far, so good. There is an opportunity to discuss how people react with their personal budgets when faced with economic hardship. A good case can be made for having an "emergency fund." And the argument for wise use of credit all the time is strengthened.

But these stories provide more opportunities. I think they provide a chance to discuss whether decreased use of credit cards necessarily translates into decreased spending. Over the long-run, I think the argument is certainly positive. But in the short-run, how does a recession affect the propensity to spend or save?

Certainly, a case can be made that consumers may not choose to reduce consumption when faced with adversity. If we look at recent recessions, one of the more interesting aspects was how consumers continued to spend (resilient was the term used frequently). According to many, that spending was supported by the wealth effect, the increased portfolio values many had as a result of investment in the 1990s. Granted the stock market stumbled, but other assets were not affected significantly, including real estate.

This brings us to the current situation. This recession is undoubtedly deeper than was the 2001 downturn. (And we may or may not even have seen the end of it, in which case it is longer than that event.) But this recession included a huge hit on the asset side of many personal balance sheets. The value of homes dropped. Sometimes they dropped to levels where outstanding mortgage balance was greater than the home's value. The owners were "upside down." That, combined with loss of jobs, or even just anxiety about the future, can provide an explanation for the action described in the articles in The Journal and The Post.

I welcome your thoughts.

***UPDATE***
Here's another article from the Thursday, October 8 edition of The Washington Post. It's basically a follow-up to the story from Wednesday's edition that's linked above.