Recently released data from the Federal Reserve show US households have much greater purchasing power than the conventional wisdom believes.  Mainstream thought is that US consumers are still up to their eyeballs in debt and, therefore, can't increase consumer spending.

But the Federal Reserve's latest figures on household finances, particularly the household financial obligations ratio, refute this so-called common knowledge.   The financial obligation ratio measures the share of our after-tax income that we have to use to make payments based on the things we've already bought.  It includes mortgage payments, rent, car loans, car leases, homeowners' insurance, property taxes, and all other kinds of debt service, such as for consumer and student loans. 

In mid-2007, the obligations ratio was pushing a record high of 18.9%.   Now the ratio is down to 17.0%, the lowest since 1998 and below the 30-year average of 17.2%.  If recent trends continue for the next three months, the Fed will report the lowest obligations ratio since 1995.  The obligations of renters (relative to their after-tax incomes) are already the lowest since 1993 and the consumer-debt obligations for homeowners are the lowest share of after-tax income since 1995.  The mortgage obligations of homeowners are still at 2005 levels, but falling rapidly.

In addition to the decline in the obligations ratio, there are other reasons that consumers have greater purchasing power.  First, total "real" (inflation-adjusted) cash earnings in the private sector are up at more than a 4% annual rate so far this year.  So rising pay gives workers the chance to both increase their purchases and pay down debt.  Second, even if earnings were flat, as long as workers pay down their debts more slowly than they did in 2008-09, they would have more to spend.

It's also important to remember that even if consumer debts are high, that doesn't necessarily limit total consumer spending.  Remember, one worker's debt is someone else's asset.  So if Peter owes Paul a lot of money, the payments may limit Peter's spending, but enhance Paul's.

With data like this, it's clear to see that the conventional wisdom continues to be too pessimistsic about the US consumer and about the economy.