Capital Spending and Consumer Spending

Earlier today I posted a couple of bullish views and I disagreed with the projections of an "Immaculate Recovery". Former IMF chief economist Michael Mussa suggested that consumer spending wouldn't lead this recovery, but that business investment would be strong.

This graph shows the general relationship between capital spending and consumer spending (ht Jan Hatzius, Capital Spending: The Caboose of a Slow Train). Note: Consumer spending lagged two quarters for best fit.

Click on graph for larger image in new window.

This suggests that consumer spending needs to pickup to above 1.5% year-over-year growth rate for business investment in equipment and software to be positive. If businesses expects consumer spending to pick up sharply, maybe they'd invest more - but few business owners expect a sharp pickup.

There might be a boost in capital spending because of a replacement cycle, but with all the slack in the economy (capacity utilization is near record lows and almost double digit unemployment), I definitely don't expect business spending to lead the recovery (as Mussa suggested).