Too much or too little household spending an economic risk in 2012

The picture for 2012 that the Bank of Canada Monetary Policy Report paints is of a Canadian economy constrained by a fragile global economy and dependent on continued, strong household spending. And, although inflation is expected to stay around 2% in 2012 and into 2013, too much or too little household spending could dislodge that outlook.

Canadians have voiced their concerns about rising inflation (Knowledge Bureau Report, Jan. 11) but all indications are inflation poses little threat in 2012. Statistics Canada this week reported a 2.3% rise in the consumer price index (CPI) for the 12 months to December, on the back of declining gas prices. Bank of Canada's core inflation ó which excludes eight of the more volatile components of the CPI ó was 1.9% in 2011.

Says the Bank of Canada in its report: "Core inflation is projected to moderate through 2012 to a level somewhat below 2%, as excess supply persists and the effects of higher prices for food and clothing on year-over-year inflation unwind. Total CPI inflation is projected to continue to decline to around 1.5% by mid-2012, reflecting lower core inflation as well as the gradual impact on gasoline prices of the decline in world oil prices from their peak in the second quarter of 2011. Both total and core inflation are expected to start to rise gradually by the end of 2012, reaching 2% by the third quarter of 2013 as excess supply in the economy is slowly absorbed, the growth of labour compensation increases modestly and inflation expectations remain well anchored.î

The Bank, however, cites three upside risks to that scenario: climbing global inflation, stronger-than-expected U.S. growth and too much household spending. Risks on the downside are failure to contain the European crisis and too little household spending.

So, how did household spending end up a linchpin of our economic stability? It wasn't so long ago that both the Bank of Canada and the International Monetary Fund were expressing concern about the levels of household debt. At the end of 2011, Canadians' household debt as a percentage of disposable income had surpassed 150%, giving the IMF reason to worry. Likewise in a Dec. 12 speech in Toronto, Bank of Canada Governor Mark Carney talked about "reducing our economy's reliance on debt-fueled household expenditures.î

But, later in his speech, Carney also noted: "To eliminate the household sector's net financial deficit would leave a noticeable gap in the economy. Canadian households would need to reduce their net financing needs by about $37 billion per year, in aggregate. To compensate for such a reduction over two years could require an additional three percentage points of export growth, four percentage points of government spending growth or seven percentage points of business investment growth.î

What has become clear is that those alternatives may not be available. With the worsening global outlook and slowing U.S. growth, Canada is not likely to see much in the way of export growth. Governments are facing mounting deficits, the result of recession-fighting incentive programs, and are cutting spending. Businesses, although in good shape financially, are taking a cautious approach to investment spending given the global outlook and will no doubt fall short of that seven-percentage-points goal.

So, it comes back to household spending. Says the Monetary Policy Report: "Confidence effects stemming from the weaker and more uncertain global outlook are projected to exert only a modest dampening effect on Canadian household spending. Reflecting the upwardly revised profile for residential investment, household expenditures are now expected to remain high relative to GDP over the projection horizon and the ratio of household debt to income is projected to rise further.î

What does Canadian household spending look like? According to StatsCan's 2009 Survey of Household Spending (the most recent data available), average household spending in Canada was $71,120. That average household spent 20.2% of its income on personal taxes, 19.8% on shelter, 13.7% on transportation and 10.2% on food. That left 36% for other spending.

At each end of the spectrum, the one-fifth of Canadian households with the lowest income spent an average of $23,860 in 2009 while one-fifth of households with the highest income spent an average of $147,090. The lowest-income group spent almost 52% of that on food, shelter and clothing while the highest-income group allocated 27%. Personal taxes, on the other hand, represented 2.8% of the lowest-income household's budget and 30% of the highest-income household.

Canadian's did cut back marginally on discretionary spending in 2009. Spending on household furnishing and recreation declined; for example, spending on snowmobiles fell 11%.