March 17, 2023 | 13:24
Services Demand: The Third Leg of Resiliency
Services Demand: The Third Leg of Resiliency
While the financial sector is under stress from the Fed’s fierce tightening campaign, the broader economy’s muffled response to date is one reason inflation remains elevated. Recent Focus articles discussed two factors buffering the economy from tighter policy: excess savings and strong job growth . But there’s a third pillar as well: the unleashing of deferred services spending. This begs the question: how much bottled-up demand exists?
On the surface, there appears to be little unfulfilled aggregate demand left. Due to massive stimulus cheques, by March 2021 real consumer spending had returned to the trend it would have been on had it continued to grow at the average 5-year rate before the pandemic (Chart 1). Since then, total spending has largely held to the pre-pandemic trend, as robust growth in services (more than double the norm) countered a decline in goods. However, services were still 1.6% below trend as of January 2023. Assuming they continue to rise at the rate of the past six months, some pent-up demand could last through 2023. And, if goods spending holds steady as households deplete extra savings, total consumption could rise modestly versus trend by year-end.
A look under the hood reveals some notable moves within major sub-groups. (Table 1). In the first two years of the pandemic, demand for durable goods soared as households borrowed at rock-bottom rates and were restricted from (or fearful of) attending in-person events. Leading the pack are books (Chart 2), musical instruments, and recreational goods and vehicles. By contrast, an initial rush to buy furniture and appliances quickly faded as the housing market slumped and credit costs soared. Used vehicles were held back by lean supplies and spiraling prices. However, spending on new vehicles was much stronger than suggested by unit vehicle sales, reflecting a shift toward purchases of more profitable (and more available) high-end light trucks and electric vehicles.
Among nondurable goods, clothing picked up its socks after an initial stumble, despite the slow return of workers to the office (at 50% of pre-pandemic occupancy based on average Kastle card swipes in ten U.S. cities). By contrast, fewer commuters and more expensive gasoline held back fuel consumption, while soaring food prices took a bite out of groceries. Notably, egg consumption cracked after prices spiked 70% y/y due to the avian flu’s crippling effect on hen supply. While food inflation has moderated, prices are likely to stay high due to the severe drought across much of the country.
The service sector, which accounts for two-thirds of personal consumption, needs to make up ground. Spending at the cinema has flopped, still two-thirds below trend and no encore in sight due to streaming services (Chart 3). Enduring behavioural changes and health concerns likely also explain softer demand for personal care services and live entertainment (excluding sports). Public transportation continues to lag due to remote working. Soaring costs and limited supplies of motor vehicles have dented auto rentals. Bucking the trend is strong demand for spectator sports—apparently fans are loyal to teams and players that can throw, kick or hit a ball or shoot a puck with pin-point accuracy (Chart 4). Also tracking higher are indoor dining, hotels and air travel, with airline executives citing continued strong demand.
The Fed’s problem is that interest rates have less effect on services than on goods, which are more likely to be financed. Robust spending on labour-intensive activities is propelling employment, wages and prices higher. The leisure and hospitality sector continues to punch well above its weight in creating jobs. This means the Fed might need to clamp down harder on loan costs. But note that discretionary services could be the first item on the chopping block if the economy slips into recession. That would at least help dampen inflation.
Bottom Line: The consumer’s desire to catch up on deferred services could support the economy through year-end, delaying or even averting a recession. But, as per the other two buffers—excess savings and a strong job market—the economy risks a harder landing if inflation stays sticky or recent financial stress persists.
 Can Surplus Savings Save the Expansion? Focus February 17, 2023. Why Is Employment Still So Strong? Focus January 20, 2023. [^]