The American consumer has experienced plenty of unpleasant financial surprises this year, including drastic investment losses, falling home prices and a rise in unemployment. The confirmation that the U.S. economy is now officially in recession isn't coming as a surprise, but it does have the potential to shift people's thinking and spending habits.
Consumer spending accounts for about 70 percent of the economy, so penny-pinching in response to hard times can have an effect on the real economy, and some economists warn that could make it harder to dig out of the downturn.
But how much wiggle room do consumers have in their purchasing habits? Here, some economists and consumer advocates weigh in.
Will people's spending habits change because we're in a recession?
It depends, in large part, on whether people have discretionary money to spend.
"Three-quarters of the average person's consumer behavior is pretty much essential spending, and it doesn't seem to me that there would be a lot of room there for flexibility," says Howard Rosen, a visiting fellow at the Peterson Institute for International Economics.
Rosen says he was surprised by how little financial cushion consumers have. This became apparent after he examined the consumer expenditure survey from 2007 recently released by the Bureau of Labor Statistics.
Consumers spent most of their take-home pay in six categories in 2007, including housing (34.1 percent), transportation (17.6 percent), food (12.4 percent), personal insurance and pensions (10.7 percent), utilities (7 percent) and health care (5.7 percent). These total 87.5 percent of a person's take-home income, which means that there is just 12.5 percent left over for a range of discretionary expenditures — including education, charitable contributions, clothing and haircuts.
As a result, if the average consumer wants to spend less, that is likely to mean cutting back on some "essentials," such as food, housing and health care, says Rosen.
Some people are doing just that: In October, a Consumer Reports survey found that 23 percent of respondents were putting off a doctor's visit or a medical procedure. That's in addition to spending less on discretionary items like entertainment and dining out.
Do consumers have any power to turn things around during a recession?
Collectively, consumer spending can have a major impact on the economy — but it cuts both ways. A case in point today is the auto industry. For the most part, consumers aren't purchasing new cars, and that has had a ripple effect for the entire industry, from production and parts suppliers to auto dealers.
Dan Ariely, a professor of behavioral economics at Duke University and author of the book Predictably Irrational, says, "There's no question that recessions are largely psychological."
"If I look at my stock portfolio, I get depressed," he adds. "The realization that I lost money might cause me to spend less."
Ariely says any recession is mostly about a "social coordination game." He says there needs to be collective action to achieve results that are good for everyone — not just for the individual. But that's often easier said than done. To achieve this, consumers need to be inspired by the president or other financial leaders like the secretary of the Treasury or the chairman of the Federal Reserve. President Carter attempted this, with mixed results, when he asked everyone to don a sweater in the 1970s to save energy.
If everyone keeps spending, won't that lead to greater debt problems?
Since 1970, the household savings rate has consistently declined. The Peterson Institute's Rosen says that consumers' take-home income after taxes amounts to 79 percent of their gross income.
"On average, people consume a little bit more [than what they take home after taxes]," he says, "meaning that they go into debt all the time."
Ariely says the line between the wealthy and the poor in the U.S. remains wide: "We look more like a Third World country than a Western country in that regard," he says. "Now there are a lot of people on the lower end of the income [scale] that can't possibly save."
So is there a new appetite for saving in the U.S.?
It appears that might be the case. In October, 40 percent of respondents told Consumer Reports that they were putting more money into their savings.
Where do consumers draw the line when it comes to making a purchase or waiting?
Consumers with money may end up spending more during the recession. For some, the motivation may be to take advantage of bargains. But those long used to living beyond their means will need to wean themselves from America's credit culture, says Noreen Perrotta, money editor for Consumer Reports.
"Americans have been financing a lifestyle through credit for many years now. I think that should change. I think people should re-evaluate how they spend their money and maybe be a little more frugal," she says.
There are long-term consequences associated with accumulating debt. Ariely says everything becomes more difficult — including getting a job, securing a loan or moving. Plus there are fees associated with declaring bankruptcy.
"This recession is going to increase the social inequality in this country," he says. "When we emerge out of it, the wealthy will be better off and the poor will be worse off."
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