With the Federal Reserve signaling its intent to raise its benchmark interest rate for the first time since 2006, the question is, can the economy weather the tightening of monetary policy without slowing down?
The answer, according to Wells Fargo Securities (WFC), is that the economy will be able to clear this hurdle with ease. One reason is that consumers may not change their spending behavior the way they once did in response to interest rate shifts. That’s critical, as household spenders account for two-thirds of gross domestic product.
Led by chief economist John Silvia, the economics team at Wells Fargo analyzed the links between spending and interest rates before and after the 2009 recession. They found that since 1994, consumer spending fell 1.29 percent for every 1 percent increase in credit card borrowing costs. But Wells Fargo’s research suggests that consumer spending has more recently declined only 0.44 percent for the same 1 percent increase in rates. “Changes in monetary policy are not likely to have as large of an effect on the pace of consumer spending next year as they have in the past,” wrote Silvia and his colleagues in a Nov. 24 report. They predict that the Fed’s benchmark will rise to 1 percent by the end of next year from almost zero today.
Wells Fargo’s economists attribute this change in behavior by consumers in part to the lower amount of credit available to them in this expansion compared with previous periods of growth. A toughening of financial regulations in the wake of the crisis may have also reduced consumers’ access to credit.
Because consumers have already been somewhat constrained in their use of debt, their spending won’t fall as hard as it did in the runup to the recession, when credit was widely available and they spent freely. Also, a lot of recent consumer borrowing has been for education and automobiles. Those loans are usually from banks and have to be paid down on a set schedule within a certain amount of time, unlike credit cards. That car and school loans have increased means consumers are more concerned with paying them down than piling up credit card debt that will have to be slashed when rates go up.
Finally, the incentive for households to save instead of spend will remain weak in 2015. “We expect interest rates next year to still be too low to make much of a significant difference in overall saving behavior, another support for consumer spending growth,” wrote Silvia.