By Steven K. Beckner

(MNI) – Household finances have improved, but not enough to spark a
big upsurge in consumer spending in the near future, according to
economic analysis released Thursday by the Richmond Federal Reserve
Bank.

Ongoing “deleveraging” from high debt burdens, coupled with high
unemployment and losses of household wealth due to falling home prices,
are likely to dampen consumption, write two Richmond Fed staffers.

Since consumption accounts for more than two-thirds of gross
domestic product, the findings suggest that the economic recovery is apt
to stay modest.

They tend to confirm the expectations of Richmond Fed President
Jeffrey Lacker as expressed shortly before Christmas. Lacker, who will
be a voting member of the Fed’s policymaking Federal Open Market
Committee this year, projected real GDP growth of just 2-2.5% in 2012.

“As households strengthen their balance sheets, their ability to
take on new debt to finance consumption is improving,” write Richmond
Fed economist R. Andrew Bauer and researcher Betty Joyce Nash. “But
household debt remains elevated by historical standards, and other
determinants of consumer spending remain weak.”

Accepting the findings of former Fed Governor Frederic Mishkin and
others, Bauer and Nash say consumer spending has been “very likely
affected by the decline in household wealth and the uncertainty about
when home prices would stabilize.”

The authors of the Richmond Fed Economic Brief observe that “recent
indicators suggest that credit conditions are improving, and there are
early signs of consumer willingness to take on new debt.”

“Perhaps the most significant indication of improved credit
conditions has been the sharp decline in household financial
obligations, as indicated by the household financial obligations ratio
constructed by the Federal Reserve Board of Governors,” they note.

Nevertheless, there is a long way to go before household finances
and in turn consumer spending are back to normal, the Richmond Fed
staffers caution.

“Given the sluggish transition in the housing market, it may take
significantly more time for these households to fully recover,” they
write. “Household deleveraging appears to have played a significant
role in the recession of 2007-09 and the anemic recovery, but the degree
to which deleveraging will continue to dampen consumer spending and the
broader economy is unclear.”

True, they say, “lower interest rates have significantly reduced
the cost of servicing that debt” and “many households have improved
their balance sheets in recent years and reduced their financial
obligations as a percent of their incomes.”

But “others remain constrained by liabilities accrued during the
housing boom and the recession,” they add.

Bauer and Nash, whose views do not necessarily reflect those of
Lacker or the Richmond Fed, write that “the household sector as a whole
… has made progress in repairing balance sheets, as suggested by
modest improvements in credit conditions.”

But they point to remaining impediments.

“Continuing declines in home prices have diminished household net
worth, and further home price weakness is expected,” they write. “Weak
employment growth and persistently high unemployment have curtailed
income growth and created uncertainty about future income.”

“Consequently, consumers may remain cautious about spending and
taking on more debt until there is greater clarity regarding labor
markets and the housing sector,” they conclude.

** Market News International **

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