But Still Up Solidly in Fourth Quarter

• Personal income rose 0.3% in December, with after-tax income up 0.2%.
• Consumer spending fell 0.6% but was up strongly in the fourth quarter.
• PCE inflation was 0.4%, slowing from October and November.
• Income and consumer spending growth will remain solid throughout 2022.
• Inflation will slow over 2022 but will remain higher than the Federal Reserve would like, leading to a tightening in monetary policy.

Personal income, before inflation, rose 0.3% in December from November. Wages and salaries led growth, up a strong 0.7%, thanks to big wage gains and solid job growth. There was a more than 1% decline in self-employment income, however. After-tax personal income increased 0.2% in December. Personal income increased at a solid pace through the last three months of 2021, up 2.1% annualized, even after the expiration of extended and expanded unemployment insurance benefits in September. Personal income growth was revised higher in both October and November.

Consumer spending fell 0.6% in December, the first decline since February. Consumers moved their holiday purchases up in 2021 because of concerns about short supplies, leading to solid growth in the late fall, but a decline in December. Spending on goods was down 2.6% in December, while services spending was up 0.5%. Consumer spending growth was revised higher in October, but somewhat lower in November. Even with the December decline, consumer spending was up almost 10% at an annualized rate in the fourth quarter, before inflation.

With personal income up and consumer spending down over the month, the personal saving rate rose to 7.9% in December, from 7.2% in November.

The personal consumption expenditures price index rose 0.4% in December, after increases of 0.6% in October and November. The core PCE price index, excluding volatile food and energy prices, was up 0.5% in December, the same pace as in November. On a year-ago basis overall PCE inflation was up 5.8% in December, up from 5.7% in November and 4% in the spring of 2021. Core PCE price inflation was 4.9% in December, an increase from 4.7% in November and 3.5% in the spring. The PCE price indices are the Federal Reserve’s preferred inflation measures, and both of these are well above the central bank’s 2% inflation objective. Overall PCE inflation is running at its fastest pace since the early 1980s, and core inflation since the late 1980s.

After adjusting for inflation, after-tax personal income was down 0.2% in December from November, while consumer spending was down 1.0%.

The personal income and expenditures report for December was a mixed bag. Personal income is rising solidly thanks to continued improvement in the labor market, especially strong wage growth as businesses raise pay to compete for workers. Consumer spending fell over the month, but growth was very good for the fourth quarter overall, up 10% before inflation and more than 3% after inflation.

Consumer spending growth will remain solid throughout 2022. An improving labor market and strong wage gains will support income growth. Households also have an extra $2 trillion saved up compared to before the pandemic that they will gradually spend down over the next couple of years. High household wealth, thanks to strong house price gains and the big runup in stock prices over the past couple of years (even with the decline in stock prices recently) are also a positive for spending growth this year and next. The biggest drags on spending in 2022 will be the ongoing pandemic and high inflation. Growth could be soft in the first quarter due to the omicron variant. Spending on goods has led growth in overall consumer purchases since the pandemic, but that will shift to services this year as the economy reopens and people feel more comfortable going out.

Inflation remains elevated, much higher than the Federal Reserve would like, although the acceleration in monthly inflation that started in the summer has come to an end. Inflation should start to slow on a year-over-year basis in early 2022 as comparisons with 2020, when the pandemic weighed on prices, start to move out of the data. Lower goods inflation as businesses work out their supply-chain issues will also contribute to lower inflation this year. Even so, core PCE inflation is likely to end this year at around 3%, above the Federal Open Market Committee’s 2% objective. The central bank is expected to raise the federal funds rate, its key short-term policy rate, by about 1 percentage point over the course of 2022 to help curb inflationary pressures.

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