There have been several important structural shifts in the U.S. economy over the past 25 years. One important recent shift has been a higher level consumption, through a multiplier effect beyond autonomous consumption, which accelerated over the past 10 years, and perhaps peaked in 2005. This article will explain the benefits and consequences of this recent shift using orthodox concepts from NeoKeynesian and NeoClassical economics.

A multiplier effect is a reinforcing cycle, e.g. a virtuous cycle of employment-income-consumption or a vicious cycle e.g. inflation-interest rates-government debt. Multiplier effects either end slowly or suddenly, depending on the magnitude and length of the effect. For example, the tech stock market bubble started when Nasdaq was below 1,000 in 1995 and ended when Nasdaq was above 5,000 in 2000. This bubble burst suddenly, since Nasdaq fell to 1,100 in 2002.

The NeoKeynesian consumption function (or identity) is Y = C + I + G + NX (or C = Y - I - G - NX); where Output (Y) is a function of Consumption (C), Investment (I), Government (G), and Net Exports (NX). Also, changes in business inventories have a short-run effect on output (note, this function is the aggregate demand curve). Over the past 10 years, Consumption and Investment have been strong (except over the mild 2001 recession), Government has been stimulative (except during the late 1990s, when taxes were high, expenditures slowed, and budgets were in surplus), and Net Exports have been negative.

There are several powerful forces that have induced greater U.S. consumer demand. The Wealth Effects of the recent housing boom and stock bull market, which both reignited in 2002, rising real incomes, changing demographics, financial innovations, lower cost of capital, particulary for durable goods, lower returns on saving, and the massive current account deficits, from international trade. These forces are interrelated and have generally worked together to increase demand.

The rate of U.S. homeownership was remarkably stable at just below 64% from 1965-95. However, in 1995, the homeownership rate started to rise, and currently about 69% of U.S. households own their homes. The strong demand for new housing, which is the most expensive big ticket good, and its related goods have been the largest contributions to domestic output. So, a slowing or contracting housing market will have a significant effect on economic growth.

Over the past 2 1/2 years, while the housing market boomed, the U.S. economy expanded at just over 4% real growth, which is above the 2.8% long-run trend. When the housing market slows or contracts, some proportion of consumption will shift into other goods, for individuals to at least maintain living standards. However, that proportion may be low, since debt levels are high and saving is low. Consequently, there may be a dramatic fall in GDP growth.

Also, many "marginal" homeowners cannot afford their homes. Marginal homeowners, including those who "traded-in" for more expensive homes, used financial innovations to purchase their homes, and then refinanced (many more than once) to maintain monthly payments, since their home values rose and interest rates fell. Eventually, there may be massive bankruptcies when it's no longer feasible to refinance or when monthly payments rise.

However, strong recent U.S. consumption was not limited to the housing market and related goods (e.g. furniture, fixtures, appliances, and insurance). Demand for autos, another big ticket item, reached record levels recently, because of lower prices, zero-percent financing, and large rebates. Moreover, demand for electronic items remained strong, while prices fell or new products were introduced. Furthermore, prices of many non-durable goods have fallen.

Lower prices induce consumption. Many argue that the CPI (Consumer Price Index), which has risen recently, understates inflation. However, there's a valid argument that the CPI is overstated, because of continued strong demand, high debt levels, and low saving. Most Americans live month-to-month, and monthly payments for many items have fallen, because of lower prices and lower interest rates. Consequently, the "rational" choice is to spend more and save less.

The NeoKeynesian production function (which is the aggregate supply curve) is Y (or i) = t(L, K, R, E....X); where Output or Inflation (Y or i) is a function of Technology (t) and Inputs (e.g. Labor, Capital, Raw Materials, Energy, etc.). The 80 million U.S. Baby-Boomers, born between 1946-64, are in their peak productive years, based on education, experience, and training. Consequently, labor productivity also had an upward structural shift starting in 1995.

The massive current account deficits contribute to consumption in at least three ways: The flood of imports puts downward price pressures on all goods, U.S. firms have to become more productive to compete with cheap imports, which "frees-up" resources for emerging industries, and massive capital account surpluses are created, to keep the balance of payments balanced, which lower interest rates, and help fund private investment and government expenditures.

The deterioration of the current account indicates the U.S. has been relatively stronger than the rest of the world. The U.S. economy has expanded with large negative net exports, while many of our major trading partners needed export-led growth, to maintain acceptable levels of output and employment. The U.S. consumer has been the engine pulling the rest of the world's economies. However, this engine of growth will inevitably slow.

The period of overconsumption with high debt and low saving, generally since 1995, from the housing boom and other factors is unsustainable. It's uncertain how quickly the housing market will decelerate. However, there are indications that the housing boom peaked in the third quarter of 2005. Fortunately, there are other factors, including a pick-up in employment, which will partially offset a slowing or contracting housing market. So, perhaps, real GDP growth will slow from around 4% to a more sustainable 3% in 2006, and the consumption bubble will deflate slowly.