Confidence Hits a New Low. Entering 2009, the economy continues to face challenges both from the producer side and the consumer side.  Recent news that the Conference Board’s index of Consumer Confidence slid to an all-time low of 38.0 and that several manufacturing indices have dipped to some of their lowest levels in history only serve to corroborate the bleak outlook shared by most American households and businesses.

Credit markets still frozen. Financial and credit markets have experienced a tremendous disruption due to downgrades in the values of assets, limited access to private short-term financing, and an overall loss of confidence in debt instruments and company solvency.  The federal government has taken broad action to restore confidence in financial markets and jumpstart the flow of funds between businesses.  Though some of these actions have helped to stabilize a system on the brink, the market for mortgage-backed securities still has yet to recover, making it difficult to stimulate demand in the housing market.

Households struggling with loss of wealth. Consumers are not only reluctant to make major purchases, but they are also spending much less on purchases across the board.  The Bureau of Economic Analysis reported that nominal consumer spending fell 0.6 percent in November and private surveys of retail sales indicate that the downward trend in consumer spending continued in December as same-store sales dropped nearly 1 percent from last December. Since 2000, households have actually seen their purchasing power decrease as real incomes stagnated.  Many relied on home equity credit to finance their purchases, which worked so long as home prices increased.  With the bursting of the housing bubble, households not only saw this form of wealth disappear, but many were forced to come to grips with their lower real purchasing power.  It began with rising mortgage delinquencies among some of the hardest hit, but has expanded to be a macro-level problem, contributing to a chain of lower confidence, reduced business spending, mass layoffs and unemployment, and in turn further consumer spending reductions and defaults.

Need for fiscal stimulus going forward. Last month, the Federal Open Market Committee reduced the target primary lending rate to a range of 0 to ¼ percent, suggesting that monetary policy options are now more limited. Financial indicators suggest that banks are still reluctant to lend to one another, which ultimately translates to higher interest rates for consumers.  This isn’t entirely surprising given the tendency not to want to invest in a still-collapsing housing market, where new sales reached a historic low in November and prices in most markets continued to falter (See Chart).  In fact, consumer prices across the board have begun to decline, suggesting a threat of protracted deflation.  With price deflation, consumers tend to delay larger purchases as they anticipate lower prices for goods in the future.  Stemming the contraction in the housing market, overall price deflation, and rising unemployment should be top concerns when the new Congress debates a new fiscal stimulus package to bring much needed to relief to struggling households and businesses.