What You Should Know

Income is what people earn through either direct labor or as owners of investments. The amount of income we earn as individuals and families connects to the economy’s prosperity and strength. It dictates how much we can ultimately spend and the value we bring to the economy as a whole. The amount of income earned collectively as a country determines the economic health of a nation and of groups within it.

Economists look at national income (covered further under #4 GDP), per capita income (income generated per person), and household income (how much income is generated by the average household). In all but the worst times, incomes should rise as people accomplish more by becoming more skilled and productive at their jobs and in their businesses. Economists also speak of real income increases—that is, increases adjusted for inflation, as opposed to nominal increases, which represent the raw numbers but not necessarily true income growth.

Economists also consider disposable income, or the amount of income actually available for individuals and families to spend after taxes. Disposable income is a truer indicator of how much purchasing power we really have, and how much of that purchasing power will ultimately be available to drive the economy and create more income.

The Census Bureau measures income annually through the American Community Survey. Income figures are published in the financial press and can be seen in greater detail on the U.S. Census Bureau’s website: www.census.gov/hhes/www/income/income.html.

You can see how income is distributed among different population groups or states, as well as overall income growth. The annual press release will contain statements like: “Real median household income in the United States declined by 1.5 percent between 2010 and 2011, reaching $50,054.” The decline in median household incomes—some 8.1 percent since 2007—has been persistent, and is one of the reasons that our leaders are so concerned about the economy these days.

Why You Should Care

Most of you probably care more about your personal income than that of the nation or others around you! Your own income ultimately determines your purchasing power and is a key factor in your overall quality of life. If your income isn’t increasing—or worse, if it is decreasing—you know that’s not a good thing, and you might have to adjust your way of life.

Watching published income figures helps you keep tabs on the ups and downs of the economy. By itself that may or may not interest you, depending on your profession or general level of interest in national success. However, if you track national, household, and per capita income changes and compare them with your own, you can see whether you’re gaining or losing ground.

Income changes can also be useful as a measuring stick for other economic factors, like growth in asset prices. During the real estate boom, for example, home prices far outpaced gains in income. Smart economists knew this couldn’t last forever. Either incomes had to rise (to keep pace) or home prices had to stabilize or fall (to allow incomes to catch up). So watching gains in income can be a good test to make sure other economic changes make sense.

See also: #2 Consumption, #4 Gross Domestic Product (GDP), and #14 Distribution of Income and Wealth.

2. CONSUMPTION

Quite simply, consumption is what we, in aggregate, consume. And like income, the measurement of consumption at a national level helps us understand whether the economy is getting weaker or stronger. As an individual, you have more control over consumption than income, so it’s important to monitor your consumption to be certain you can make ends meet.

What You Should Know

Economists track personal consumption expenditures (PCE). As the term implies, PCE represents funds spent on goods and services for individual consumption. “Goods” breaks down into durable goods—goods expected to have a useful life greater than three years, like cars and lawnmowers—and nondurable goods like food, paper products, cleaning supplies, and so forth. Personal consumption expenditures exist in addition to private business investment, providing goods and services for export, and government consumption of goods and services.

The Bureau of Economic Analysis (www.bea.gov) monitors and publishes PCE reports; the Bureau of Labor Statistics (www.bls.gov) gives longer histories and projections for PCE. Since consumption accounts for some 71 percent of the total U.S. economy, a small change in PCE can signal a big change in prosperity ahead.

Why You Should Care

At a national level, during the boom years prior to the Great Recession, low interest rates, easy credit, and low-cost imported goods combined to cause a consumption bubble of massive proportions; the Great Recession was in part an unwinding of that bubble. Savings rates (covered in the next entry) went from negative to moderately positive as consumers became more conservative. This caution has brought consumption back to more sustainable levels—that is, somewhat less than income and more in line with income growth.

That’s a good thing on a national basis. The key for you as an individual is to make sure your own PCE is in line with your income and income growth. And if you’re an investor, monthly PCE reports can give you an insight to where the economy is headed.

3. SAVING AND INVESTMENT

The personal saving rate is defined, very simply, as the percent of personal income that is not consumed. In specific economic terms, it is personal disposable income minus personal consumption expenditures. In real-world terms, it’s money you don’t spend today but instead put aside to spend tomorrow.

Investment, on the other hand, is an allocation of goods or capital not to be used just for current but also future production. Over time, when an economy is in balance, saving should equal investment; that is, the money, or wealth, put aside should be invested, or used, for future consumption.

Granted, that sounds a bit complicated and theoretical. As a practical matter, it’s more interesting to look at saving as it has really occurred over time. It’s also more interesting to think about how saving and investment should occur in your own household.

What You Should Know

First, it’s important to distinguish “saving” from “savings.” Saving is the setting aside of surplus funds—that is, what you don’t spend. Savings refers to the actual accounts, like your savings accounts, in which you do it. The level of “saving,” not “savings,” is what’s really important for you and for the economy as a whole.

Consumer saving, until recently, had been on the skids for quite some time. For many years we were a nation of savers: in the 1960s saving was 6 to 10 percent of income, and rose to a level as high as 14 percent briefly in the recessionary period of 1975 (yes, saving rises during economic hardship; see #35 Paradox of Thrift).

In the late 1970s, saving rates started to decline because of high inflation rates—people needed more of their income to meet expenses and came to expect the purchasing power of their savings to diminish. Saving rates fell back to the 8 to 10 percent range, still healthy by today’s standards. The 1982 recession increased it to 12 percent; that peak foreshadowed a long, slow decline into the 6 to 8 percent range by the late 1980s, down to 2 percent in the late 1990s, and hitting negative territory by 2005. It has hovered near zero since then; however, in the aftermath of the Great Recession, the savings rate rose to about 5 percent, as people feared for their jobs and incomes, and has settled a bit to the 3 percent range. That sudden return to saving, ironically, hampered the recovery (see #35 Paradox of Thrift).