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When will we spend again?
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October 26, 2001: 6:00 p.m. ET
Consumer spending is the key to the U.S. economy. When will it recover?
By Staff Writer Mark Gongloff
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NEW YORK (CNNmoney) - Americans usually have no problem spending money, but it hasn't been so easy lately.
Consumer spending makes up two-thirds of U.S. gross domestic product (GDP), the broadest measure of economic health. It has held up well this year, keeping the economy afloat, despite a recession in the manufacturing sector and a sharp slowdown in spending by businesses.
But businesses cut hundreds of thousands of jobs in response to sluggish demand, eroding consumer confidence even before Sept. 11. That day's terrorist attacks set confidence back even further.
"It created a 'bunker mentality' among consumers, who are more centered around the home, shopping less often, and spending less freely," said Merrill Lynch analyst Daniel Barry.
The prospect of falling consumer demand has most economists expecting a recession, commonly defined as two consecutive quarters of shrinking GDP, to follow the attacks.
"Without a doubt, there will be a contraction in the third quarter's GDP of approximately 0.9 percent," said Sung Won Sohn, chief economist at Wells Fargo & Co. "Given the slow start in October, the most likely scenario calls for a larger contraction in the 2.8-percent range in the fourth quarter."
So when will consumers recover and start shopping again, and how will we know it? Though uncertainty rules the day, there are some helpful guides to present and future consumer behavior.
1. Retail sales
One of the most obvious canaries in our national coal mine is retail sales, and the Commerce Department's report of monthly retail sales is due Nov. 14. Sales fell 2.4 percent in September, the biggest drop in at least nine years.
The Federal Reserve, in its latest Beige Book report on business activity, said retail sales dipped sharply in the days after Sept. 11, as stunned Americans limited their purchases to groceries and other essentials.
Retailers have reported that sales bounced back quickly to pre-attack levels. The only problem is that those levels weren't particularly good anyway, and most analysts expect a blue Christmas for retailers, with slower sales growth in the five-week shopping season.
"Retailers like dollar stores, discount stores, and warehouse clubs should report positive comparable-store sales for Christmas, as their sales are relatively recession resistant," said Merrill Lynch's Barry, "while department stores and upscale retailers should have distinctly negative results."
2. Home sales
Though not as crucial as consumer spending, the housing market, supported by low mortgage rates, was one of the last pillars of strength in the economy before the attacks.
Home equity accounts for 44 percent of family wealth for the 72 million families that own homes, according to David Lereah, chief economist for the National Association of Realtors, and the health of the housing market is indicative of how consumers are spending their money.
Click here for CNNmoney.com's economic calendar
Unfortunately, the market has been struggling lately. Though housing starts rose in September, sales of existing and new homes fell sharply, and fewer builders applied for permits to start new home construction.
"The housing sector is finally showing that it isn't resilient to everything," said Tim Rogers, chief economist at Briefing.com.
Still, most agree the fundamentals of the market are strong, and David Berson, chief economist at mortgage lender Fannie Mae, said he expected the housing downturn to be "the smallest of any in the postwar period."
3. Consumer confidence
So far, the two major gauges of consumer sentiment have shown some hopeful signs.
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Kathleen Hayes takes a look at the impact of home sales on the economy.
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The Conference Board's consumer confidence index fell in September, as expected. But the University of Michigan's consumer sentiment index rose, if only slightly, in October after a steep drop in September, and consumer expectations for the future also rose, according to a Reuters report.
And a special Conference Board survey Friday found that, while most consumers expect a recession after the attacks, 90 percent of them don't expect to change their spending plans.
But most economists expect the Conference Board's index for October, due next Tuesday, to fall again and for sentiment to worsen as the economic picture worsens and job cuts mount. A setback in the war on terrorism or another terrorist attack could make things worse.
"Consumers at this juncture are fighting the forces of the economic slowdown with patriotism," said Anthony Chan, chief economist with Banc One Investment Advisors. "As economic conditions continue to deteriorate, this challenge will become greater."
4. Unemployment
A weakening labor market has probably had the biggest impact on consumer spending and confidence, and it's likely to get worse in the coming months.
Though the unemployment rate stayed at 4.9 percent in September, nearly 200,000 jobs were cut that month. When the Labor Department reports on October unemployment next Friday, economists expect many more job cuts and an unemployment rate above 5.0 percent. That's bad news for consumer spending.
"If people lose their jobs, they're not going to go buy a car," Chan said.
And unemployment is a lagging economic indicator, meaning companies will keep cutting jobs even after the economy begins to recover because they want to make sure the recovery is real.
"That's why confidence is important," said Wells Fargo's Sung Won Sohn. "If it remains healthy, gains in sales will be high enough to offset the negatives coming from job cuts. It's a tug-of-war; right now, job cuts are winning."
5. Economic Stimulus
To make borrowing easier and encourage consumers to spend, the Fed has cut its target for short-term interest rates nine times this year to their lowest level since 1962. The Fed is widely expected to cut rates again at its next policy meeting, scheduled for Nov. 6, but economists are divided about how big the cut will be.
There's also a debate among politicians and economists about what sort of government stimulus is better suited for the current economic environment. The House of Representatives approved a package that focused on giving tax breaks and other incentives to companies, encouraging them to spend money to improve production.
But companies may not choose to spend that money until they know demand is going to justify higher production, meaning it could take a while for that money to trickle down to the consumer.
"The corporate tax cuts may not have an economic impact until months later," Sohn said.
Others want the package to focus more on giving tax breaks to lower-income families, who would seem more likely to spend the money quickly, giving a short-term boost to the economy. But the last tax "rebate," which many Americans started getting late this summer, didn't quite have the effect lawmakers wanted - most people put it in savings or used it to pay down debt.
Other factors
The stock market will likely play a key role in boosting consumer confidence. After plunging in the first week of trading after the attacks, the major U.S. stock indices have rallied. A surge this week was especially encouraging, since it flew in the face of lackluster corporate profits and seemingly constant reports about new anthrax contaminations.
Though it's old news, the Commerce Department's report on personal income and spending in September, due Nov. 1, will be interesting as a measure of the immediate impact of the terror attacks on consumers.
In any event, most economists expect consumers to spend again. The only question is one of timing.
"All this stimulus is going to work," said Banc One's Chan, "just not overnight. It's probably going to take a couple of quarters to work itself out." 
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U.S. consumer sentiment index revised downward - Oct. 26, 2001
Durable goods orders, existing home sales plunge - Oct. 25, 2001
Fed Beige Book: Economy slow in September, October - Oct. 24, 2001
Survey of U.S. businesses sees sharp economic weakness - Oct. 24, 2001
Federal Reserve cuts interest rates for 9th time in 2001 - Oct. 2, 2001
U.S. consumer confidence falls - Sept. 25, 2001
Recession could follow terror attacks, but it might not last long - Sept. 20, 2001
Consumers hold the key - Sept. 13, 2001
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