Is this really surprising ? No, US household debt is so large that consumers are now being compelled to save more and spend less. This doesn't bode well for the US economy. Here's a good article with three scenarios for the US economy (from the Levy Economics Institute):

http://www.levy.org/docs/stratan/prospects.html

Nescio -

The need for added saving is especially important when also considering the aging of the population. Added saving, reduced consumption, reduced corporate earnings....

Several economists are wondering whether the approach to retirement of the baby boom generation will also be the cause of a reduction of price/earnings ratios for stocks that will limit market gains for years to come. Aging boomers are not likely to continue pouring money into stocks as they pass their prime earning years, while the generation that will replace them is smaller by 27 million and so will not be investing in stocks to the extent of their parents.

Brad has written recently that the low American savings rate for a generation has been very puzzling. Perhaps we will begin to see a rise in the ratio as baby boomers realize they are saving short as retirement draws near.

This will be the 3rd year in a row in which American household wealth declines. There was no year in which household wealth declines from 1945 to 1999. The S&P index is still down about 40% from the level of December 31, 1999. This stock market wealth loss must be a problem though homes have appreciated in value for 3 years. This wealth loss seems worrisome to me though the press makes little of it.

Retail sales are down, and the conclusion is the Fed should have lowered rates even sooner? I guess this is the fall-back of all those who have proposed monetary policy to boost the U.S. economy for so long. If the economy still doesn't pick up, it's not that the advice (Fed should lower interest rates) was bad or wrong - no, it should just have been done sooner! I guess the great thing about economists is you never have to say you're sorry; the economy's a complex system, so you can always find some reason why things didn't turn out the way you expected.

All the data may just fit a simpler explanation - monetary policy ain't going to do it this time folks. The lower-interest-rate program has succeeded in getting the U.S. consumer into such debt that lowering them even more just won't help.
Lower rates has worsened rather than obviated our difficulties.

Paul Krugman has been saying for some time this has been your grandmother's recession, not your mother's. The need has been greater demand and the Fed supplied much through lower interest rates and the boom in refinancing, housing, and auto sales. Not enough. Fiscal stimulus however seems to have had a minimal impact.

Though interest rates are lower than in several decades, household debt has increased these past 3 years. "Perhaps" there is a growing reluctance to take on more debt. Perhaps.

The need now would be for fiscal stimulus, but remember that Japan has had little success other than to continue slow GDP growth with fiscal stimulus that is aimed far more at the middle class than the American fiscal stimulus has been.

Yes, good old Keynesianism. Not enough spending, we need more government!

As the drumbeat of comments indicate - what we need is not lower rates.

I still don't get the relationship between lower Fed rates and increased business spending. as I see it, the conventional logic is:

1: fed cuts rates
2: Banks get cheaper money
3: They can lend cheaper to businesses
4: Businesses get cheaper money
5: They borrow and embark on that capital expansion plan they have been putting off for a while because rates were too high

... but, banks don't automatically keep a constant risk premium while rates get marginally lower. The spreads don't tighten by the equivalent amount of the cut, the Prime does not follow the rate cut. Now what?

We have significant overcapacity. What incentive does a business have to borrow to increase capacity (and I use the term in the broadest sense - marketing, new factories, new products all fall under capacity)?

The perverese effect of all these rate cuts is increased fees to Wall Street investment banksers as companies constantly try to retire older and more expensive debt with newer, marginally cheaper debt. But much like home refi, how often can you realistically refi?

What we need now is an old fashioned spending binge by the government in the sectors that have the broadest impact: education, infrastructure (a national railroad system that effectively replaces 25% of car travel comes to mind), rapid transit systems in all major cities...

Old fashioned fiscal stimulus is what we need.

So, Prof DeLong, I argue that the timing of the cuts did not matter. Had the cuts happened sooner, we would have seen nothing different - not while there is so much uncertainty over employment and current production overcapacity.

Our empirical knowledge of the macro-dynamics of monetary policy is so poor that the best justification I can find for a sharp and fast drop interest rates is that of the need to be decisive when jump-starting an engine... You sure don't want to drawn your motor... :) Or am I missing an important piece of the litterature?

Remember, part of a fiscal stimulus could have been and could still be a lowering of the marginal tax rates for lower income women and men. Payroll taxes could be lowered for a demand spur.

Also, I am wondering whether the aging of Japan, western Europe, and more slowly America is playing a part in a lack of sufficient demand. Will we need to adjust thinking of economic policy, simply because we are aging?

What by the way do you make of the economic vibrancy of China?

Brad: "Bad news about consumer demand this Christmas season. It's a sign that the Federal Reserve waited too long to cut interest rates further. The possibility of a slide back into full recession is now alive once again..."

Waited too long to cut interest rates further? Perhaps the Fed should not have been so aggressive in lowering interest rates. Higher interest rates would have forced the economy into a recession, a necessary one in order to correct some of the imbalances in the economy. In my opinion, the Fed has been making matters worse by cutting interest so aggressively and is now in the process of moving into a trap where the Japanese central bank has been for years: zero interest rates and no ways to stimulate the economy. The Fed has argued that it won't let this happen, but I'm afraid it's simply too late. Japan had a bubble in the stock market and in real estate and is still paying the price for its exuberant economy in the 1980s.

>>Higher interest rates would have forced the economy into a recession, a necessary one in order to correct some of the imbalances in the economy<<

WHat are the imbalances in the US economy, and how would they have been cured by a recession?

In related news, I'd back up Suresh's point by suggesting a look at the yields on BBB-rated non-financial commercial paper, a decent proxy for the cost of working capital loans. Despite rate cuts, the overall borrowing cost has been flat for most of 2002 ...

dsquared: WHat are the imbalances in the US economy, and how would they have been cured by a recession?

* current account deficit: 5% of GDP
* budget deficit: 3.1% of GDP and counting....
* private sector balance: -2.5%
* household indebtedness as % of income: 108%

A recession is likely to lower the current account deficit,move the private sector balance (savings of businesses and individuals) in positive territory and lower the indebtedness of US households, as there will be less imports and more saving by corporations and individuals. The yields of corporate fixed income instruments have risen dramatically over the past couple of years, reflecting a higher risk premium. This higher risk premium was demanded by investors because many firms were overleveraged and made the wrong investments. Businesses are now rebuilding their balance sheets, which should lower the risk premium and their cost of capital in the coming years. The US consumer has yet to embark on the balance sheet restructuring process that has been underway at US corporations and that can only mean cutting spending.

"The yields of corporate fixed income instruments have risen dramatically over the past couple of years, reflecting a higher risk premium."

That statement is flatly false. The spread to treasuries of corporate bonds has certainly increased but absolute yields have definitely fallen.

And, more generally, how would inflicting a recession improve the consumer debt picture?

What by the way do you make of the economic vibrancy of China?

Completely off-topic, but China's economic numbers are made up.