During the recent financial crisis, the Federal Reserve and other policymakers throughout the government took unprecedented actions to mitigate the fallout from severely distressed market conditions and support the flow of credit to consumers and businesses. Nonetheless, the level of credit outstanding for households has been very slow to rebound and remains lower than it was at the onset of the crisis.

[A]lthough consumer credit shows some signs of thawing, responses to our Senior Loan Officer Opinion Survey on Bank Lending Practices suggest that lending standards to households generally remain tight.²

The early stages of past recoveries have been led by consumer spending, particularly for durable goods and residential investment... It is unlikely that we will experience this type of strength this time.

Those of you who have heard me speak previously, both here and elsewhere, know that I frequently point out that consumer debt levels are too high and that individuals must save more.  So, how does that position align with my statements about the importance of consumer spending in the recovery and our broad economy?  If the U.S. is to reduce its dependence on other countries for credit and support that its private and public investment demands, savings and consumption must return to more historical norm.  But like the decline itself, the adjustment process must proceed gradually or we risk disrupting consumption to such an extent tha twe undremine the economy itself.  The challenge is to establish the appropriate pace of change.

I also think that a massive shift in consumer behavior is under way—one that will produce great benefits in the long run but slow our recovery in the short term…In the long run, higher saving promises to channel resources from consumption to investment, making capital more readily available to retool industry and fix our infrastructure. But, in the here and now, such a rediscovery of thrift means fewer sales at the mall, and fewer jobs on assembly lines and store counters.

[A]s people come to grips with the fact that their finances are more uncertain than they had ever thought they would be, they are not likely to resume spending at the pace they once did. As a result, we should not expect consumer spending to return to the 70 percent share of GDP that it posted just before the recession began.

[W]hile the announcement that the Social Security trust fund will begin its decline one year earlier is an important fiscal event, the swelling of overall entitlement debt to more than one hundred trillion dollars has far more serious implications for economic growth—implications we are poorly positioned to address given the budget deficits we face today.

Our successor generations are coming to grips with this daunting reality. Faced with the prospect of a government that they believe may be unable to deliver on its promise of long-term fiscal balance—particularly with regard to entitlement programs—these individuals might logically begin to alter their consumption patterns, spending less today to save more for tomorrow. There is nothing wrong with increasing savings. But, in an economy driven by consumption, this intertemporal hedging may dampen the pace of future economic growth.

You have to put into perspective the way I behaved on fed funds in the context of how the system works or does not work. When we got to 3.5% [at January’s unscheduled policy meeting] and were starting to go below that, my personal bias was to make sure we got all of the plumbing working. The question really is about the efficacy of the system. Will consumers and small businesses benefit from these rate cuts?

When asked about his "strong reluctance" to further easing.

Lacker expressed skepticism about declines in various gauges of consumer confidence or consumer sentiment. He called them "kind of crude measures" and said "it's hard to make anything out of them."

"Sometimes they dip sharply without any deflection in the path of consumer spending," he said, while "sometimes they are a harbinger of significant (slowing) of consumer spending."

From comments to press, as reported by Market News International

With respect to consumer spending, a long list of factors can be expected to have a depressing effect going forward.

Thus far, the quality of other consumer loans has remained satisfactory. However, the delinquency rates on credit cards and consumer installment loans at banking organizations increased over the second half of the year. Moreover, although household bankruptcy filings remained below the levels seen before the changes in bankruptcy law implemented in late 2005, the bankruptcy rate rose modestly over the first nine months of 2007 and could be a harbinger of increasing delinquency rates on other consumer loans. In view of this risk, Federal Reserve supervisors are monitoring these consumer loan segments for signs of spillover from residential mortgage problems, particularly in regions showing homeowner distress, and are paying particular attention to the securitization market for credit card loans.

There is concern that there are in fact structural limitations on the ability of consumers to finance consumption.

From audience Q&A as reported by Market News International

The softer labor market, together with factors including higher energy prices, lower equity prices, and declining home values, seem likely to weigh on consumer spending in the near term. On the other hand, growth in U.S. exports should continue to provide some offset to the softening in domestic demand, and the recently approved fiscal package should help to support household and business spending during the second half of this year and into the first part of next year.
 

The Federal Reserve is one of a growing number of organizations that have already taken some implications of behavioral research to heart. This year, we began to automatically enroll new employees into our System’s savings plan, defaulting them into an asset allocation fund that includes fixed income, domestic, and international equity investments. Employees who do not want to participate can, of course, easily opt out. But our early experience mirrors well-known research findings: so far, an overwhelming fraction of employees who were defaulted in remain in. Of course, this choice reflects the Federal Reserve System’s appreciation of the striking findings of behavioral economics concerning the sensitivity of saving decisions to default enrollments.

A rise in saving can achieve that shift because the extra savings would be used to increase the nation’s stock of capital and increase our net holdings of foreign assets.  Increasing the amount of productive assets owned by Americans increases the amount of consumption that future generations will be able to enjoy.  Determining the best way to distribute the burden associated with the aging of the population should be high on society’s list of priorities.