Economist's View

'How Are American Workers Dealing with the Payroll Tax Hike?'

Basit Zafar, Max Livingston, and Wilbert van der Klaauw examine the impact of the payroll tax cut in 2011 and 2012, and its subsequent reversal:

My Two (Per)cents: How Are American Workers Dealing with the Payroll Tax Hike?, by Basit Zafar, Max Livingston, and Wilbert van der Klaauw, Liberty Street Economics, NY Fed: The payroll tax cut, which was in place during all of 2011 and 2012, reduced Social Security and Medicare taxes withheld from workers’ paychecks by 2 percent. This tax cut affected nearly 155 million workers in the United States, and put an additional $1,000 a year in the pocket of an average household earning $50,000. As part of the “fiscal cliff” negotiations, Congress allowed the 2011-12 payroll tax cut to expire at the end of 2012, and the higher income that workers had grown accustomed to was gone. In this post, we explore the implications of the payroll tax increase for U.S. workers.

The impact of such a tax hike depends on two factors. One, how did U.S. workers use the extra funds in their paychecks over the last two years? And two, how do workers plan to respond to shrinking paychecks? With regard to the first factor, in a recent working paper and an earlier blog post, we present survey evidence showing that the tax cut significantly boosted consumer spending, with workers reporting that they spent an average of 36 percent of the additional funds from the tax cut. This spending rate is at the higher end of the estimates of how much people have spent out of other tax cuts over the last decade, and is arguably a consequence of how the tax cut was designed—with disaggregated additions to workers’ paychecks instead of a one-time lump-sum transfer. We also found that workers used nearly 40 percent of the tax cut funds to pay down debt.

To understand how the tax increase is affecting U.S. consumers, we conducted an online survey in February 2013. We surveyed 370 individuals through the RAND Corporation’s American Life Panel, 305 of whom were working at the time and had also worked at least part of 2012. ...

After a presentation of the survey results, and a discussion of what they mean, the authors conclude:

Overall, our analysis suggests that the payroll tax cut during 2011-12 led to a substantial increase in consumer spending and facilitated the consumer deleveraging process. Based on consumers’ responses to our recent survey, expiration of the tax cuts is likely to lead to a substantial reduction in spending as well as contribute to a slowdown or possibly a reversal in the paydown of consumer debt. These effects are also likely to be heterogeneous, with groups that are more credit and liquidity constrained more likely to be adversely affected. Such nuances may be lost in the aggregate macroeconomic statistics, but they’re important for policymakers to consider as they debate fiscal policy.

In response to arguments that tax cuts wouldn't help because they would be mostly saved, I have argued that there are two ways that tax cuts can help (see Why I Changed My Mind about Tax Cuts). One is to increase spending, and the other is to help households restore household balance sheets that were demolished in the downturn (i.e. the cure for a "balance sheet recession"). The sooner this "deleveraging process" is complete, the sooner the return to normal levels of consumption and the faster the exit from the recession (rebuilding household balance sheets takes a long time and this is one of the reasons the recovery from this type of recession is so slow, tax cuts that are used to reduce debt can help this prcess along). It looks like both effects are present for payroll tax changes (and work in the wrong way with a payroll tax increase).

'What Happens When Top Income Earners Receive Smaller Subsidies for Retirement Savings?'

Greg Mankiw complains that rich people (like him presumably) will stop saving so much if there is "some kind of penalty for people who have accumulated more than $3 million in retirement accounts" in the president's budget:

The President's Latest Bad Idea

His big complaint? "President Obama's $3 million constraint would be a significant disincentive for saving."

Here's something to consider via Owen Zidar:

What happens when top income earners receive smaller subsidies for retirement savings?: Raj Chetty, John N. Friedman, Soren Leth-Petersen, Torben Heien Nielsen, and Tore Olsen ask this question and answer it here.

When individuals in the top income tax bracket received a smaller tax subsidy for retirement savings, they started saving less in retirement accounts….. but the same individuals increased the amount they were saving outside retirement accounts by almost exactly the same amount, leaving total savings essentially unchanged. We estimate that each $1 of government expenditure on the subsidy raised total savings by 1 cent.

...

I saw this paper presented at an NBER meeting at the SF Fed. It is very impressive work. I'm surprised Greg is unaware of it.

'Shut Up, Savers!'

James Surowiecki addresses the complaint the low interest rates are hurting people who live off their investment income:

Shut Up, Savers!, by James Surowiecki: Ben Bernanke..., according to a chorus of critics,... is one of history’s great thieves. Over the past four years, the Fed has kept interest rates near zero and has pumped money into the economy by buying trillions of dollars in mortgage-backed securities and government debt. The idea is that a so-called “loose” monetary policy can help galvanize a weak economy... But, to his detractors, Bernanke is guilty of waging a “war on savers”—fleecing people, especially retirees, of hundreds of billions of dollars that they could have earned in interest. Among many conservatives, this notion has become mainstream. ...

Certainly, it’s not the easiest time to live off interest income. ... No wonder people with lots of savings want the Fed to ... raise interest rates. But most Americans depend on wages and salaries for their livelihood, not on interest income, and higher interest rates would hurt the job market... Also, most Americans have more debt than savings, which means that they benefit directly from lower interest rates. ... Even seniors, one of the groups most obviously hurt by low interest rates, get only ten per cent of their income from interest payments. Bernanke has been accused of waging class warfare and forcing senior citizens to eat cat food, but the simple fact is that people who are net savers are, on average, wealthier than those who aren’t.

And what if the Fed did raise interest rates? It’s unlikely that savers would be better off in the long run, since the move would slow down the economy as a whole and perhaps even tip us back into recession. ... Indeed, the biggest culprit when it comes to low interest rates isn’t the Fed: it’s the weak economy... That’s why interest rates are low across most of the developed world—even in countries where central bankers haven’t been buying up assets the way the Fed has. ...

Currently, the big risk isn’t that the Fed will wait too long to raise interest rates; it’s that pressure from savers will cause it to raise them prematurely. The economy may be looking a bit perkier, but it’s still growing slowly, and it has an enormous amount of ground to make up... It may be hard for people to live off their savings these days, but the far more urgent problem is that it’s even harder for people who don’t have jobs, or whose wages are stagnant, to save anything at all.

There's another important point. Currently, as explained here by Paul Krugman, the interest rate is at the zero bound and therefore cannot fall to the level consistent with full employment. Here's his graph to illustrate this point:

What would raising interest rates do in this case? It would increase savings, but decrease investment making the imbalance (and the recession) even worse. As Krugman says:

The policy problem is that for whatever reason — in current conditions, mainly the deleveraging taking place after an era of debt complacency — the interest rate that would match savings and investment at full employment is negative. Unfortunately, that’s not possible, because rather than lend at a loss people can just hold cash. So we have an “incipient” excess supply of savings, which is eliminated not via a fall in interest rates but via a fall in income, i.e., a depression.

Now, the figure above may look familiar from microeconomics; it’s more than a bit like the standard analysis of a price floor that creates a persistent excess supply of a good, such as the way European price floors on agricultural products created butter mountains, wine lakes, etc..

One way to think about macro policy in a liquidity trap is that it’s about trying to reduce that incipient surplus, say through government spending to make use of the excess savings.

But what the people who want to raise rates are demanding is that we take the price floor that is causing this destructive surplus, and raise it higher.

Yes, savers would like higher returns, just as farmers would like higher prices for their butter. But free-market oriented economists, of all people, should understand that you can’t just decree higher returns without paying a price in economic disruption.

Inequality and Savings

This is from Oya Celasun of the IMF:

How Inequality Affects Saving Behavior, by Oya Celasun: ...Recent research has focused on the link between income inequality and growth, but less attention has been paid to the link between inequality and savings. So ... our study looked at which types of households drove the aggregate saving rate down before the crisis and those that drove it up afterwards...

Saving patterns before the crisis ...Our key finding is that that households with consistently lower income growth experienced larger declines in their saving rates and a larger rise in their mortgage debt before the crisis. We also find that these types of households contributed significantly to the overall decline in the saving rate. ...

Our results suggest that households with disappointing income growth attempted to preserve their living standards in the boom years by tapping into their housing equity. Their decisions did not anticipate the impending correction in house prices, the weaker economy, and lower incomes. The easy availability of home equity financing allowed households with low income growth to at least temporarily “keep up with the Joneses”... With the subsequent housing crash, those households already suffering from lowest income growth found themselves more vulnerable, with high levels of debt. ...

Saving patterns after the crisis How did households fare after the crisis? We found that those more dependent on housing wealth and those with higher debt levels on the eve of the crisis indeed raised their savings sharply after the crisis. Yet, as this sharp correction started from very depressed and even negative saving rates, these households have not yet made meaningful progress in reducing debt and repairing their balance sheets. Hence, these households may face grim future consumption prospects.

Taken together, our results do suggest that the lower income growth for segments of the income distribution was linked to the drop in saving rates and growing indebtedness of American families. Moreover, households that entered the crisis with a more precarious wealth situation have made limited progress in rebuilding their net worth ... by actively saving out of their incomes. ...

Unless their incomes and house prices pick up robustly, many households will need sustained levels of higher savings to rebuild wealth, making it less likely for the American consumer to drive U.S. growth.

Why Do the Wealthy Save So Much?

Larry Willmore:

Why do the wealthy save so much?, by Larry Willmore: ...The standard theory of saving behavior, known as the ‘Life Cycle’ hypothesis,... does the model explain why Bill Gates and Warren Buffet are giving away almost all their wealth before they die, just as steel tycoon Andrew Carnegie (1835-1919) did a century ago.

The Life Cycle model assumes that the only purpose of saving ... is to finance future consumption. Johns Hopkins economist Christopher D. Carroll in 1997 showed how and why “the model greatly underpredicts the amount of wealth held by the households at the top of the wealth distribution”. His essay is as relevant today as it was 15 years ago.

Here is a key paragraph from the conclusion:

A variety of evidence, both qualitative and quantitative, strongly suggests that people at the top end of the wealth and income distributions behave in ways that are substantially different from the behavior of most of the rest of the population. In particular, it is difficult to explain the behavior of these consumers using the standard Life Cycle model of consumption. A leading alternative to (or perhaps just an extension of) the Life Cycle model is the Dynastic model in which the decision maker cares about the utility of his descendants. The Dynastic model, however, has problems of its own, starting with the testimony of many wealthy households who say that providing an inheritance is not a principal motivation for saving and ending with the fact that childless wealthy old people do not appear to dissave. I argue that the simplest model capable of fitting all the facts is a [`Capitalist Spirit'] model in which wealth either enters the utility function directly as a luxury good, or wealth yields a stream of services that enter the utility function in ways that would be formally virtually indistinguishable from a model in which wealth enters the utility function directly.

Christopher D. Carroll, “Why Do the Rich Save So Much?“, The Johns Hopkins University, July 1997. ...

"It's Not Structural Unemployment"

Rebecca Wilder:

It's not structural unemployment, it's the corporate saving glut, by by Rebecca Wilder: ...I'd argue that ... the corporate saving glut is ... creating high and persistent unemployment. Some economists are wrongly referring to this as higher structural unemployment...

The chart below illustrates a simple univariate regression of the unemployment rate on the corporate saving glut. The correlation is very strong, 71%, and suggests that the structural unemployment rate is less than 5.8%. Furthermore, while the unemployment rate seems to be perpetually higher than normal (the upper-right circle), that perfectly coincides with a high corporate saving glut.

If the corporate excess saving glut just equaled zero, i.e., firms invested and saved at the same rate, the unemployment rate would be 5.8%. Now, if the corporate saving glut fell below zero to -2%, i.e., firms reinvested in the economy by way of capital investment in excess of saving, the simple model implies an unemployment rate of 4.7%.

The government doesn't need to add jobs, per se, the government needs to figure out how to get corporate America to drop the saving glut and re-invest in the economy.

A Tax on Saving?

Bob Cringely says a tax on saving by high income individuals would jump start the economy:

Motivating Miss Daisy, by Bob Cringley: ...I’ll throw out one last idea that ... relies entirely on greed and self-interest to succeed. Those are two commodities we appear to have in limitless amounts. ...

Rich interests have ... shown an amazing willingness to do the most arcane and complex things to avoid paying taxes. Remember the tax shelters of the 1980s? ... The ... logical solution to restarting the economy, then, ... is a short-term tax (or tax credit — they are the same thing if you squint) on savings. Forget about accelerated depreciation — make all non-reimbursed expenses of any kind 100 percent deductible in the current tax year.

It’s ass-backward, I know, but it would work. Give rich people a short term incentive to spend like poor people, then phase it out over time.

If we are metaphorically in the same position as FDR in 1938, this wacky policy would please the right while giving a financial boost equivalent to World War II but without the war. Recession over.

Households’ Balance Sheets and the Recovery

This is why I still think tax cuts need to be part of a recovery package, and that it's okay if those tax cuts are saved:

[full-sized version]

Quite a bit more on this here: Households’ Balance Sheets and the Recovery, CBS MoneyWatch.

Update: After posting this, I realized I should have said something about distributional issues, and it's coming up in comments. The point that the problem is largest for the middle class and blow is hinted at in the last paragraph of the quote from the original Cleveland Fed article, but I didn't make it explicit enough. I was intending to update the post to include this, but fortunately Mike Rorty covers this issue in a follow-up post to this one, so let me send you there: The Distribution of Households’ Balance Sheets and the Recovery.

Why are Firms Saving So Much?

The Economist asks:

Why are Firms Saving So Much?

My answer is here:

Look at the difference between large and small firms

Additional responses from Xavier Gabaix, Hal Varian, Andrew Smithers, Scott Sumner, and Brad DeLong, with more to follow (all).

Why I Changed My Mind about Tax Cuts

I posted this at MoneyWatch a few days ago:

Why I Changed My Mind about Tax Cuts, Maximum Utility: When the recession first hit, and the need for government action became apparent, a debate began over the steps the government should take to try to turn things around. One point of contention was whether tax cuts or increases in government spending would have the largest impact on the economy.

Tax cuts have an advantage over increases in government spending since they can be implemented relatively quickly. Government spending programs take more time to put into place.

But there is also a disadvantage. Unlike government spending, which has an initial impact on demand that is certain and one to one, tax cuts give households and incentive to spend more, but there's no way to ensure that the tax cuts won't be saved instead of spent. And if they are saved instead of spent, then they don't produce the desired increase in aggregate demand. However, if the tax cuts are well targeted, then the amount that is spent rather than saved will go up, but even then the impact on demand is still less certain than for government spending.

The experience from the first attempt at using tax changes to stimulate the economy, the Bush tax rebate of Spring of 2008, suggests that temporary tax cuts of this variety are largely saved. Here's an estimate of the effect of the Bush tax rebates from the Congressional Budget Office. It shows that the rebates drove income up quite a bit, but consumption hardly budged:

The lack of impact on aggregate demand (consumption) is due to how the tax rebates were distributed. The tax rebates went to a lot of people who really didn't need them, and they chose to save the extra money.

But better targeting can fix this. Thus, I thought that the best way to do the second stimulus package, the one Obama put into place a little over a year ago, would be to have well-targeted tax cuts go into effect as fast as possible to give the economy an initial jolt. This would be followed by government spending, which takes a bit longer to put into place. As this spending came online it would sustain or even strengthen the impact on aggregate demand provided initially by the tax cuts, and, importantly, the spending would be sustained until the economy was clearly on its way to recovery.

The stimulus package that was put into place by the Obama administration to fight the recession was constructed along these lines. Though many people don't realize this, just under 40% of the total stimulus package was devoted to tax cuts.

However, though the targeting was better than for the Bush tax rebates, the tax cuts weren't as well targeted as they could have been if the goal is to maximize the impact on aggregate demand (i.e. if the goal is for the tax cuts to go to consumption, not saving), and not all of the tax cuts went into effect immediately when they were most needed.

Initially I was critical of how the tax cuts were targeted since so much ended up going to saving rather than consumption. This is the part I am rethinking.

There are different types of recessions, and this one can be termed "a balance sheet" recession. It had a big impact not just on bank balance sheets, but on household (and, for that matter firm) balance sheets as well. Households were particularly hard hit due to declines in stock prices and declines in the value of housing. These losses were large, they upset plans for things such as retirement, and households needed to refill the holes in their balance sheets that had been created (this includes paying off debt).

How do they refill their balance sheets? By saving more and consuming less (paying off debt is a form of saving). Thus, as the recession took hold, we saw a large increase in the saving rate and a corresponding fall in consumption. The tax cuts were an attempt to reverse the decline in consumption, but instead they mostly raised the amount that went into saving.

But that has a benefit. Households are not going to start consuming normally again until their balance sheets are repaired. The faster the holes in their balance sheets are refilled, and tax cuts can help with this, the faster the households can return to their normal rates of consumption -- a prerequisite for the economy to return to normal.

So the targeting of the tax cuts that was OK after all. You don't see the effects of balance sheet rebuilding in the data initially because the tax cuts are being used to fill up balance sheets, there's no immediate effect on consumption, output, employment, etc., to observe in the data. But since balance sheets are refilled faster, we will emerge from the recession sooner, and that's an important benefit of tax cuts that's often overlooked.

There's one more important aspect of this. While the balance sheet rebuilding is going on, there's very little impact on aggregate demand, and since stimulating aggregate demand is a key to recovery, that must come from somewhere else. If we move the tax cuts from, say, higher income households to lower income households that will increase aggregate demand, but it will also slow the rate of balance sheet rebuilding and hence cause the recession to last longer.

Instead, we should do both. Give tax cuts to some households knowing full well they will use them to fix balance sheet problems, and also give tax cuts to households who will spend rather than save the money (because they need the money to help to pay bills, etc.), and do so in sufficient quantity to provide the necessary stimulus to aggregate demand. Then, as outlined above, follow this up with aggressive fiscal policy action and job creation programs that sustain the impact on aggregate demand until the economy is ready to stand on its own once again.

In balance sheet recessions, tax cuts that are saved will help to end the recession sooner and hence should be part of the recovery package. The most important concern is still aggregate demand, and policies must be devoted to this problem first and foremost, but tax cuts have a role to play in the recovery process even when they are saved.

Is the Personal Saving Rate Headed to Seven Percent?

Macroadvisors says the saving rate won't rise as much as some people are expecting:

The Saving Rate Does Not Have to Rise to 7% in the Near Term, Macroavisors: The argument that the personal saving rate is headed to 7% is based on a long-term relationship between the wealth-to-income ratio and the personal saving rate (pictured above) that is assumed to be stable over time. In fact, this long-term relationship shifts for reasons that are well understood. ...

Over the next 2 years, the relationship between the wealth-to-income ratio and the personal saving rate is expected to shift in such a way as to suggest only modest upward pressure on the personal saving rate — enough pressure to suggest an increase to about 3½% — but not nearly enough pressure to raise it to 7%.

Tim Kane of Growthology has a survey of 76 economics bloggers. In the survey that is about to be published, I asked about the saving rate after the economy recovers (74 responses):

In the post-recession economy, the savings rate will ...
		Answer Options	Response Percent	Response Count
		be substantially higher than before the recession	12%	9
		be somewhat higher than before the recession	66%	49
		return to its pre-recession level	20%	15
		be lower than before the recession	1%	1

I was in the "somewhat higher" group. Update: here's a visual representation:

"The Long-Term Impact of the Mortgage Crisis"

Richard Green is concerned about the old people of the future. Are they saving enough today?:

The long-term impact of the mortgage crisis--and why it keeps me awake, by Richard Green: My parent's generation behaved differently than mine in all sorts of ways. A paper of mine with Hendershott shows that they spent less, controlling for education, etc., throughout their life cycle than any other generation. One of the reasons for this is that they paid off their mortgages. According to the American Housing Survey, 70 percent of households headed by someone over the age of 65 have no mortgage at all. Loan amortization became a mechanism for forced saving, and as a a result, those born during the depression are in pretty decent shape financially. ...

My generation is different. Even under the most benign circumstances, we refinance in a manner that slows amortization. I refinanced ... twice to take advantage of lower interest rates--this was, of course, the right thing to do financially. But each time, the amortization schedule reset, and so it extended the period at which the mortgage would pay off. Now yes, one can take the money one doesn't put into home equity and put it in other savings vehicles, but it is not clear that everyone does that. Forced saving is slowed.

But this is not the worst of how people have handled their mortgages. A substantial fraction of borrowers pulled equity out of their houses, putting themselves on a lower savings path even in the absence of falling house prices.

I am going to run some American housing survey data on this, but it is hard for me to imagine that 70 percent of my generation will have no mortgage debt when we are elders. My parents' generation has used housing wealth to, among other things, finance long-term care. I hope I am missing something here, but the lack of housing wealth in the future could become yet another challenge as we seek to fund the needs of the elderly.

"Interest Rates at Center Stage"

Like Tim Duy in the post above this one, David Altig is also puzzled by analysts who, to quote from the FOMC minutes highlighted in Tim's post, that "banks might seek to reduce appreciably their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially":

Interest rates at center stage, by David Altig: In case you were just yesterday wondering if interest rates could get any lower, the answer was "yes":

The Treasury sold $44 billion of two-year notes at a yield of 0.802 percent, the lowest on record, as demand for the safety of U.S. government securities surges going into year-end.

"Demand for safety" is not the most bullish sounding phrase, and it is not intended to be. It does, in fact, reflect an important but oft-neglected interest rate fundamental: Adjusting for inflation and risk, interest rates are low when times are tough. ...

The intuition behind this point really is pretty simple. When the economy is struggling  ... the demand for loans sags. All else equal, interest rates fall. In the current environment, of course, that "all else equal" bit is tricky, but the latest from the Federal Reserve's Senior Loan Officer Opinion Survey is informative:

"In the October survey, domestic banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households. ..."

Demand also appears to be quite weak:

"Demand for most major categories of loans at domestic banks reportedly continued to weaken, on balance, over the past three months."

This economic fundamental is, in my opinion, a good way to make sense of the FOMC's most recent statement:

The Committee… continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

Not everyone is buying my story, of course, and there is a growing global chorus of folk who see a policy mistake at hand:

Germany's new finance minister has echoed Chinese warnings about the growing threat of fresh global asset price bubbles, fuelled by low US interest rates and a weak dollar.

Wolfgang Schäuble's comments highlight official concern in Europe that the risk of further financial market turbulence has been exacerbated by the exceptional steps taken by central banks and governments to combat the crisis.

Last weekend, Liu Mingkang, China's banking regulator, criticised the US Federal Reserve for fuelling the 'dollar carry-trade', in which investors borrow dollars at ultra-low interest rates and invest in higher-yielding assets abroad.

The fact that there is a lot of available liquidity is undeniable—the quantity of bank reserves remain on the rise:

But the quantity of bank lending is decidedly not on the rise:

There are policy options at the central bank's disposal, including raising short-term interest rates, which in current circumstances implies raising the interest paid on bank reserves. That approach would solve the problem of… what? Banks taking excess reserves and converting them into loans? That process provides the channel through which monetary policy works, and it hardly seems to be the problem. In raising interest rates paid on reserves the Fed, in my view, would risk a further slowdown in loan credit expansion and a further weakening of the economy. I suppose this slowdown would ultimately manifest itself in further downward pressure on yields across the financial asset landscape, but is this really what people want to do at this point in time?

If you ask me, it's time to get "real," pun intended—that is to ask questions about the fundamental sources of persistent low inflation and risk-adjusted interest rates (a phrase for which you may as well substitute U.S. Treasury yields). To be sure, the causes behind low Treasury rates are complex, and no responsible monetary policymaker would avoid examining the role of central bank rate decisions. But the road is going to eventually wind around to the point where we are confronted with the very basic issue that remains unresolved: Why is the global demand for real physical investment apparently out of line with patterns of global saving?

Does America Need "A Moral Revival"?

Andrew Leonard's bad day:

The brighter side of high unemployment, Andrew Leonard: ...BusinessWeek contributor Gene Marks ... gloats about how high unemployment is good for his business. I guess any publicity is good publicity... But he didn't pick a good day. Having already been irritated enough by David Brooks, I can't say I was exactly in the mood for an explanation of why high unemployment is great for small businesses because now there are so many "good, bright, educated people" who are "willing -- no, let's admit -- grateful to work for less money and longer hours."

Even better, the bad economy provides cover for getting rid of that "dead weight" that you were feeling too guilty to throw overboard. ... And the capper:

Because let's face it: The upside to the high unemployment rate is that it has helped us control our payroll costs. No one's asking for raises. No one's demanding more benefits. ...It's now easier and more politically correct to hire part-timers, subcontractors, and other outsourced help to fill the gaps. That's because when people are out of work, they'll do whatever they've got to do to bring in cash.

I understand that Gene Marks is ... a small business owner (he sells customer relationship management tools), who is attempting to speak to other small business owners, all of whom, presumably, are also delighted that the potential hiring pool is so chock full of talent desperate to be exploited right now.

But one wonders who exactly is supposed to purchase all those products and services from the small businesses of the world, if unemployment creeps up to the 10 percent mark or higher? High unemployment means low consumer demand. Which usually means small businesses end up going out of business, or at the very least, laying off more employees, who push the unemployment rate even higher. And so on. Low employment might mean it would be harder to find qualified employees, but it also means more customers with money burning a hole in their pockets. Which scenario, do you think, is better for society in general?

I have no problem with contrarian arguments. But a look back at the oeuvre of Gene Marks suggests that in his efforts to be routinely contrarian, he ends up coming off as, well, how can I be polite? What's the opposite of insightful?

Here's what set him off:

The decline and fall of David Brooks, by Andrew Leonard: America needs "a moral revival," declares David Brooks... We are drowning in a sea of debt, and this is because we have lost our moorings; we have abandoned our tradition of Calvinist restraint, self-denial and frugal responsibility. If we don't start living right, we run the risk of cultural failure, that time-honored historical pattern in which "affluence and luxury lead to decadence, corruption and decline."

My my my. I've seen some high horses in my day, but David Brooks is perched on a saddle so far aloft in the clouds of self-delusion that he can't even see the earth, much less reality. Let's examine his thesis more closely.

Americans ran up a lot of debt in the last few decades. There's no question about that. But one of the most striking developments of the last year has been how Americans have responded to the financial crisis at an individual level. We made a collective decision to start saving and stop spending. Is this because we woke up one morning last fall and suddenly became born-again Calvinists? No, it seems clear that we were responding rationally to economic incentives. The economy crashed, unemployment surged, home prices plummeted, and presto: We all started pinching pennies. Morality, insofar as expressed via our spending habits, is merely a reflection of the economy.

To his credit, Brooks acknowledges this point. But then he immediately dismisses it:

Over the past few months, those debt levels have begun to come down. But that doesn't mean we've re-established standards of personal restraint. We've simply shifted from private debt to public debt.

This, Brooks suggests, proves that "there clearly has been an erosion in the country's financial values." Elsewhere he suggests that our cultural decline began sometime around 1980.

Brooks displays a bizarre historical amnesia throughout his column. For example, he never even mentions the transition from the Roaring Twenties to the Great Depression. Maybe it's because the shift from decadence to thrift at that point was also obviously a response to economic incentives. Even worse, a moral revival didn't restore economic growth after the Crash -- government action and ultimately the fiscal stimulus provided by World War II did the trick.

But a far more pertinent point of reference comes much earlier. Has Brooks somehow forgotten that just nine years ago the U.S. operated under a balanced budget and enjoyed a budget surplus? The explosion of public debt since that point has very little to do with the moral failings of Americans, and everything to do with objective fact. George W. Bush cut taxes, but did not match those cuts with spending cuts. Instead, he ramped up spending dramatically, on two wars, healthcare, and finally, a huge bailout of Wall Street.

Bruce Bartlett has calculated that even without Obama stimulus-related spending increases, the current deficit for fiscal year 2009 would be about $1.3 trillion instead of $1.6 trillion. If you are a believer in Keynesian economics, you can make a pretty good case that Obama's additional spending is designed to get the economy growing again, so as to avoid even worse deficits in the future. Do nothing, and a shrinking economy means lower tax revenues and higher social spending. Morality has very little to do it -- the appropriate, responsible fiscal choice at this point is for government to spend, while the people save.

Obama would be in much better position to do what's appropriate, of course, if he hadn't been saddled with a trillion-dollar deficit when he walked in the door. But the responsibility for that does not belong with some widespread betrayal of America's founding puritan values. It belongs explicitly to the party in control over the last eight years.

Update: Paul Krugman:

Moral decay? Or deregulation?, by Paul Krugman: Andrew Leonard is unhappy with my colleague David Brooks for suggesting that rising debt in America reflects moral decay. Surprisingly, however, Leonard doesn’t make what I thought was the most compelling critique.

David points out, correctly, that something changed around 1980 — that consumers started spending a larger share of national income and that debt began increasing. Although he doesn’t point this out, this was also when the federal government first began running substantial deficits even in good years.

David would have you believe that what happened then was a decline in Calvinist virtue. But, um, didn’t something else happen around 1980? Can’t quite remember .. someone whose name begins with the letter “R”?

Yes, Reagan did it.

The turn to budget deficits was a direct result of the new, Irving-Kristol inspired political strategy of pushing tax cuts without worrying about the “accounting deficiencies of government.”

Meanwhile, the surge in household debt can largely be attributed to financial deregulation.

So what happened? Did we lose our economic morality? No, we were the victims of politics.

Output, Productivity, Employment, Household Debt, Consumption, and Wealth

Two from the Antonio Fatás and Ilian Mihov Global Economy blog. First, Antonio Fatás notes cross-country differences in how productivity has evolved during the crisis, and he speculates that the difference may be due to differences in how much effort was devoted to reducing the impact of the recession on employment:

Output, employment and productivity during the crisis, by Antonio Fatás: While most advanced economies have displayed significant drops in GDP during the last years, the behavior of labor market variables (employment, unemployment, number of hours) has been quite different across countries.

In countries such as the US or Spain we have seen a large decline in employment/hours and the corresponding increase in unemployment. In countries such as Germany or France or Sweden, employment and hours have fallen much less.

Below is data on labor productivity measured as GDP per hour worked in four countries... In the case of Sweden and Germany we can see that the fall in GDP has been much larger than the decrease in hours worked leading to a decline in productivity. In the case of the US productivity has remained stable. In the case of Spain the fall in employment and hours has been much larger than the decrease in GDP which has produced a doubling of the productivity growth rates in 2007/08 relative to the 2003-06 period.

Behind these figures we probably have a composition effect (different sectors being affected differently by the crisis) but also different labor market responses to the crisis, where in some cases there has been a conscious effort to reduce the impact on employment.

Next, Ilian Mihov argues that consumer indebtedness might not be as bad as you've been led to believe:

Household debt, consumption and wealth, by Ilian Mihov: It is very common these days to hear that the global economy has no way of recovering because the most powerful engine of global demand – the American consumer – is choking in debt. ...

Indeed,... debt stands at $14.068 trillion or slightly less than 100% of GDP. Does this mean that the economy is doomed? There are two points that one has to take into account when evaluating the role of household debt in the economy.

1. Debt is only one side of the story. Households also own assets. Consumption is a function of (net) wealth, not only of indebtedness. Up to a first approximation what matters is the difference between assets and liabilities. Indeed, no one thinks that a person with $10 million in debt is going to cut his or her consumption, if you know that this person has $10 billion in assets. So, how do American consumers fare in terms of net worth? Below is a graph with three ratios – assets-to-GDP, debt-to-GDP and net-worth-to-GDP. Although household debt stands at 100% of GDP, assets owned by US households currently stand at $67.2 trillion or 475% of GDP. The net worth of the American households is estimated to be over 375% of GDP.

Are these assets sufficient? This is hard to tell because theory does not provide convincing guidance as to what the wealth-to-GDP ratio should be. But we can look at the data to see how these numbers compare to historical averages. The average ratio of US household net worth from 1952Q1 to 2009Q2 is about 350% (if we exclude the two bubbles, the ratio is 330%). In short, US households today have more net wealth than they had in normal times in the post WWII period. Contrary to all complaints, US households today are richer than at any point in time in the pre-1995 period (and again, this is relative to GDP; in absolute terms no one will be surprised that this statement is true).

But maybe it is the composition of debt that matters – people today live off their credit cards. It turns out that consumer credit has increased indeed over the past 20 years but the numbers are not shocking. From about 14% in 1990, consumer credit rose to 17.3% in 2009 (again the numbers are relative to GDP). ...

2. Even if we concede that debt can reduce consumption for an individual, it is a bit trickier to make the same argument for the national economy. The reason is that the liability of one individual is an asset for someone else. In the graph above, the thin blue line is in fact included in the thick red line! ...

There are ways in which this “neutrality of debt” may break down. For example, if those who are indebted have a higher propensity to consume than the lenders, then debt will lead them to cut their consumption by more than the lenders will increase theirs (due to the wealth effect). This is possible and even plausible, but it is not clear whether empirically this effect is significant. Second, it might be that household debt is held by foreigners. Again, the data are not very supportive of this hypothesis because the net foreign asset position of the US is not (yet) devastating – less than 20% of GDP.

In general, many other “imperfections” in the market economy can result in the importance of debt for aggregate consumption, and I do agree that some of these imperfections are realistic and important. The main point of the argument is that we need a more nuanced view of why debt matters. We should keep in mind that the net worth of US households is still quite high (375% of GDP) and that debt should be viewed from a general equilibrium point of view and not only in absolute terms.

One quick comment. This is hinted at in the second to last paragraph, but to make it more explicit, the distribution of assets and liabilities can matter, and given the rise in inequality over much of this time period (it coincides with the rise in the green and red lines beginning in the 1970s evident in the diagram above) along with the stagnant wages of the working class, there may well have been important distributional effects.

"The Savings Rate Has Recovered…if You Ignore the Bottom 99%"

Yves Smith suggested this. I don't know if it's correct or not, as noted below most of the numbers are speculative due to data limitations, but the question of how recent changes in saving vary with income does seem like a question worth asking:

Guest Post: The Savings Rate Has Recovered…if You Ignore the Bottom 99%, by By Andrew Kaplan, a hedge fund manager: It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the “structural adjustment period” of moving back to a more normal savings rate has been completed. We’ve gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).

The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters.”

This is the kind of conventional wisdom which could only emerge among folks in the 99^th income percentile who spend their time primarily with other folks in the 99^th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.

"Savings Rate Could Stay High"

Andy Harless explains why he believes that much of the recent increase in the savings rate will be permanent, while Brad DeLong thinks "only a small part" will be permanent. My own view is somewhere between Andy's "much" and Brad's "small part": 

Savings Rate Could Stay High, by Andy Harless: Mark Thoma shows us a historical chart of the personal savings rate since 1960 and asks how much of the recent increase (from an average of about 0.5% from 2005 through 2007 to a peak of almost 7% in May of this year) is permanent? One must, of course, take the May figure with a grain of salt: the savings rate rose in May largely because tax withholding was reduced; unless that attempt at a stimulus is completely ineffective, we should expect the savings rate to decline as people start taking advantage of the new disposable income. But even before May the savings rate this year was running consistently above 4%, which is a dramatic change from a few years ago. Let’s use the April figure – 5.6% – as a guesstimate of what the “true” savings rate is right now and ask how much of that will be permanent.

Not much, thinks Brad DeLong:

I would guess that only a small part of the rise in the savings rate is permanent. Financial distress was and is much greater than in past post-WWII recessions, and financial distress is associated with transitory rises in the savings rate.

I’m inclined to disagree. Undoubtedly the savings rate will fall somewhat as the degree of financial distress declines, but I think there’s a good case to be made that much of the increase is permanent.

For one thing, from the point of view of households, “financial distress” may be extremely slow to lift. If the Japanese experience is any guide, it is a very slow process to get a severely distressed banking system to start lending normally again, and it’s not clear that things are going to be any easier for the US. Meanwhile, most forecasts expect the unemployment rate to remain quite high for several years. It could take 3 years, or 5 years, or 10 years, or 20 years before the financial distress lifts.

Granted, even 20 years is not forever, and 3 years is certainly not forever, but it’s long enough to stop thinking about household behavior as being continuous over time. We can reasonably surmise that, even without so much financial distress, the savings rate would have trended upward over time. Presumably households would gradually have come to recognize that they weren’t saving enough. (Can zero be anywhere near enough?) And as baby boomers’ children settle into their own careers, they would cease to be a drag on their parents’ savings, and at the same time those parents would have to start worrying seriously about retirement. The financial distress messed up this scenario (or maybe just speeded it up), but the underlying trend should still be going on “beneath the surface.” By the time the distress lifts, there will be other reasons for the savings rate to be higher than it was in 2006.

That argument is rather speculative, I admit, but there are more solid reasons to expect the savings rate to remain high.

How Much of the Increase is Permanent?

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Update: Brad DeLong answers:

I would guess that only a small part of the rise in the savings rate is permanent. Financial distress was and is much greater than in past post-WWII recessions, and financial distress is associated with transitory rises in the savings rate.

Update: Since we're on the topic, Martin Feldstein thinks the saving rate will be higher in the future, but not high enough to avoid increases in the real interest rate:

US saving rate & the dollar's future, by Martin Feldstein, Commentary, Project Syndicate: ...The saving rate of American households has risen sharply since the beginning of the year, reaching 6.9 per cent of after-tax personal income in May, the highest rate since 1992. In today’s economy, that is equivalent to annual savings of $750 billion.

While a 6.9 per cent saving rate is not high in comparison to that of many other countries, it is a dramatic shift from the household-saving rate... Dramatically lower share prices and a 35 per cent fall in home prices reduced household wealth by $14 trillion... Individuals now have to save more to prepare for retirement, and retirees have less wealth to spend. Looking ahead, the saving rate may rise even further, and will, in any case, remain high for many years.

The increase in the household saving rate reduces America’s need for foreign funds to finance its business investment and residential construction. Taken by itself, today’s $750 billion annual rate of household saving could replace that amount in capital inflows from the rest of the world. Since the peak annual rate of capital inflow was $803 billion (in 2006), the increased household saving has the potential to eliminate almost all of America’s dependence on foreign capital. ...

Without a fall in the dollar and the resulting rise in net exports, a higher saving rate and reduced consumer spending could push the US economy into a deep recession. By contrast, the lower dollar makes reduced consumption consistent with full employment by shifting consumer spending from imports to domestic goods and services, and by supplementing this rise in domestic demand with increased exports.

But this direct link between higher household saving and a lower dollar will only be forged if higher household saving is not outweighed by a rise in ... government deficit. A large fiscal deficit increases the need for foreign funds to avoid crowding out private investment. Put differently, the value of the dollar reflects total national saving, not just savings in the household sector.

Unfortunately, the US fiscal deficit is projected to remain high for many years. ... If that high level of government borrowing occurs, it will absorb all of the available household savings even at the current elevated level. That would mean that the US would continue to need substantial inflows of foreign capital to fund business investment and housing construction. So the dollar would have to stay at its current level to continue to create the large trade deficit and resulting capital inflow.

It is, of course, possible — I would say likely — that China and other foreign lenders will not be willing to continue to provide the current volume of lending to the US. Their reduced demand for dollars will cause the dollar to decline and the trade deficit to shrink. That reduced trade deficit and the resulting decline in capital inflows will lead to higher real interest rates in the US. The higher interest rate will reduce the level of business investment and residential construction until they can be financed with the smaller volume of national saving plus the reduced capital inflows.

Although the higher level of household saving will limit the rise in US interest rates, it will not change the fact that the combination of large future fiscal deficits and foreign lenders’ reduced willingness to buy US securities will lead to both a lower dollar and higher US interest rates.

Since the increase in the long-term fiscal deficit Feldstein is worried about is mostly due to the expectation of rapidly increasing health care costs, this points to the need for health care reform that can (compassionately) control escalating health care costs.

Update: Speaking of health care reform, Ezra Klein looks at the lessons to be learned from Clinton's attempt to reform health care:

The Ghosts of Clintoncare, by Ezra Klein, Commentary, Washington Post: Barack Obama's strategy to pass health-care reform seems based on a simple principle: Whatever Bill Clinton did, do the opposite. ... Few legislative failures have been as catastrophic as Clinton's on health-care reform. ... Yet there are aspects of Clinton's approach that could, and should, inform Obama's effort -- and not just as examples of what not to do. ... Clinton got the politics of reform wrong, but in important ways, he got the policy right. He just got it right too soon.

By the time Clinton and his team took office, the insurance market was changing. American consumers had traditionally relied on the most straightforward of insurance products: indemnity insurance. You went to the doctor or hospital of your choice, and that doctor or hospital sent your insurer the bill. Hopefully, your insurer paid it. That was that. The plans weren't confined to networks tangled in deductibles and co-pays. But they weren't holding down costs, either, and the system was becoming unaffordable. Managed care, a new system that ... envisioned a more central role for insurers ... was rapidly emerging... But this was a dangerous change. Insurers make money by denying claims. Money they spend on health care is money they lose...

So Clinton sought to cage managed care inside managed competition, which would regulate the behavior of insurers and force them to compete for patients. This would give consumers more power against their insurance companies, drive the bad actors from the market and generally protect against the excesses of managed care. Clinton's plan also included a handful of other safeguards, like out-of-pocket caps and an independent appeals process, designed to protect consumers from deficient insurance. ...

But if Clinton's team of enlightened wonks could glimpse managed care over the horizon, the public wasn't as farsighted. Bill and Hillary weren't seen as meeting and taming the managed-care revolution. The act of writing legislation that included managed care made it seem as if they were proposing it. And there was no political margin in that. Managed care, after all, means less choice. It means provider networks and insurance bureaucrats and complexity. It would have been a hard sell under any circumstances... The plan died a painful and public death...

But then a funny thing happened: Managed care came anyway ... HMOs and PPOs and HDHPs. We're all in networks now. We don't get our choice of doctor. There's no appeals process. No out-of-pocket caps. Nothing to stop insurers from rejecting ... coverage... And if we don't like our insurer? Tough. "We got managed care," says Chris Jennings,... one of Clinton's top health-care staffers. "But we didn't get the things that would protect us from managed care. We got the Wild West version of it."

In the modern health-care system,... the insurers who populate that market have grown all the stronger..., 94 percent of statewide insurance markets are highly concentrated. ... Clinton had promised us managed care within managed competition. Instead, the insurers took control of our care and managed to effectively end competition. Neat trick. ...

All of this has led to an interesting reversal in this year's health-care debate. In 1994, people feared that Clinton would restrict their choices. In 2009, people want Obama to bring their choices back. ... A ... poll last month showed that 62 percent of Americans support the choice of a public insurance option. ... But if the public option would drive private insurers out of business and reduce consumer choice, the numbers flip, with 58 percent opposing it. What people support, in other words, is not public or private insurance, but choice in insurance. That, along with protection from escalating costs, is the inviolable principle of health-care reform. ...

The lesson of Clintoncare was that even if the American people want reform, they do not necessarily want change. And so Obama's health-care strategy involves a delicate effort to ... reform the health-care system without substantially changing it... But this is not the early 1990s. The indemnity insurance that most Americans enjoyed then is virtually nonexistent today. The mergers and takeovers and consolidations in the insurance market have given people less choice and thus less power. Today, the cost issue is more acute, the president is more popular, the Democrats have more seats in Congress, and the Republicans are more fractured. Obama ... was right to dismiss those who would "dust off that old playbook."

But the ghosts still hover. Republicans are fixated on what worked for them in the last health-care battle, and Democrats are overly concerned with what contributed to their failure. Just as Clinton's plan was weighed down by the impression that it would change too much, history may leave Obama's effort vulnerable to the charge that it is changing too little.

The claim that reform will give people more rather than less choice will hard to sell. Politically, I think the focus has to be on how the increase in concentration and power within the insurance industry and the control that gives the industry over the delivery of health care limits choice in undesirable ways.

A Lasting Recovery?

Olivier Blanchard argues that global imbalances must be resolved in order to put the world economy on a sustainable path to recovery:

What is needed for a lasting recovery, by Olivier Blanchard, Commentary, Financial Times: In 2007, worried about the growing size of current account imbalances, the IMF organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. ...

It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. ... And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. ... As the crisis evolves, however,... the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.

Using Inheritance Taxes to Promote Equal Opportunity

Michael Kinsley is mystified by ten Democratic senators:

Democrats for Rich Heirs?, by Michael Kinsley, Commentary, Washington Post: ...Meanwhile, the Senate is considering what to do about the estate tax. It is scheduled to be abolished next year, in one of several landmines the Bush administration set to go off after it left town. Obama proposes to reinstate the tax, at a 45 percent rate, on estates worth more than $3.5 million. Since there's no tax on what you leave to your spouse, married couples could pass on $7 million before needing to pay a dollar -- or needing to consult a lawyer who can use loopholes to save millions more.

The House has passed this measure as part of the budget. In the Senate, there's trouble. Ten Democrats have joined the Republicans in calling for a $10 million exclusion and a 35 percent rate. This is amazing. The number of people who leave estates of even $7 million is minuscule. The number leaving more than $10 million is smaller still. Yet to save these very few very wealthy people a small fraction of their estates, these senators are willing to hand their party's president an embarrassing defeat. Why on earth?

Oh, small business blah blah blah. ... To be affected by the estate tax, a business must be owned by someone of large means: at least $7 million. ...

But why the populist fury over those AIG bonuses of a few million dollars while no one seems to care much about billions being transferred through inherited wealth? The obvious answer -- that there's a difference between what people do with our hard-earned money and what they do with their own hard-earned money -- isn't actually as persuasive as it seems.

Perusing the Forbes 400 list of America's richest people, it's striking how few of them made the list by building the proverbial better mousetrap. The most common route to gargantuan wealth, like the route to smaller piles, remains inheritance. ...

Dozens of Forbes 400 fortunes derive from the rising value of land or other natural resources. These businesses are fundamentally different from mousetrap building. Land does not need to become "better" to increase in value, and that value increase doesn't produce more land. Yet other fortunes depend directly on the government. The large fortunes based on health care and pharmaceuticals would not exist if not for Medicare and Medicaid. The government hands out large fortunes even more directly in forms as varied as cable-TV franchises; cellphone licenses; drilling, mining and mineral rights; minority small-business loans; and other special treatment.

Most important, every American selling anything benefits from doing so in the world's richest market. An American doctor earns many times what the same doctor would earn in, say, India. This is not because he or she works many times harder. ... It's because we are a richer society, for reasons the American doctor had nothing to do with.

The debate over whether the estate tax should start at $7 million or $10 million is largely symbolic. That makes the push by those 10 Democratic senators for the higher amount even more mysterious.

Via Brad DeLong:

Think Progress: Lincoln’s $250 billion estate tax plan would cut taxes for only 60 ’small businesses.’: Last week, 10 Democrats in the Senate joined all 41 Republicans in voting for a $250 billion proposal to cut estate taxes... Touting the tax cut in a press release, Lincoln claimed that it was “aimed at farms and small businesses.” However, according to an analysis by the Tax Policy Center, Lincoln’s $250 billion proposal would save just 60 small businesses or farms from the estate tax:

An always charged issue is how the estate tax affects small farms and family-owned businesses. We estimate that under the Obama proposal, 100 family farms and businesses [a year] would owe tax.... The Lincoln-Kyl proposal would cut the number to 40.

According to the Congressional Budget Office, “almost all such estates are able to pay the tax bill without having to sell business assets.”

To try to overcome the political opposition, and to try to meet a worthy goal, I would increase and broaden the tax, and then earmark the revenues specifically for programs designed to promote equal opportunity, e.g. Head Start programs, funds to allow anyone to attend the college of their choice without running up large debts, or alternatively to help to start a business, and so on. To further help with the political opposition, the collected funds, or more precisely the programs the funds support, would be made available to everyone on an equal basis.

Mortgaging the Nest Egg

This is not a good sign. A lot of people are borrowing from their retirement accounts to pay off debt:

Borrowing from the Nest Egg, by Lane Kenworthy: This news is discouraging, but hardly unexpected. According to a “Marketplace” report, a survey by the Transamerica Center for Retirement Studies (pdf here) finds that the share of workers borrowing from their 401(k) retirement funds increased from 11% in 2006 to 18% in 2007. Nearly half of those taking out such loans in 2007 cited the need to pay off debt, compared to a quarter in 2006.

Stagnant wages and salaries, most spouses already employed, rising health care and college tuition costs, higher mortgage debt loads, and falling home values mean lots of American households — including many middle-income ones — are pinched financially. The late 1990s economic boom lessened the strain for a while. Then home equity loans helped. More recently, credit card usage has jumped. Borrowing against retirement savings is the logical next step.

See more discussion here, here, and here.

This is why I wonder about the long-term participation rate in "opt out" retirement accounts that are being promoted as a way to deal with the retirement security problem. How many people will opt out of these accounts when economic conditions for the household deteriorate temporarily for some reason? And once they opt out, will they opt back in? People who are motivated enough to borrow against their retirement accounts - almost one fifth in 2007 - would also be motivated enough to opt out of an automatic savings plan. Many of the studies, at least the ones I have seen, do not track people over long periods of time where this type of deterioration would be present, and they do not follow people through a recession when the pressure to opt out would be greatest. I'm not saying we shouldn't have these programs, they do help some people save, and even if some people opt out at least they have a source of funds to use when times get tough. The point, though, is that the people most likely to opt out are the very ones we would like to see participate in savings programs so that they have more than just Social Security available during their retirement years. Because of that, we should be careful not to place too much emphasis on opt-out types of mechanisms for solving the retirement security problem. These accounts may not provide as much of a boost as we hope to key segments of the population.

Update: Megan McArdle follows up with comments on forced saving as a solution to this problem.

Richard Baldwin: Feldstein’s View on the Dollar

Richard Baldwin reviews Martin Feldstein's May 2007 predictions about the fate of the dollar, predictions he says are "looking pretty good at the moment":

Feldstein’s view on the dollar, by Richard Baldwin, Vox EU: President Kennedy said “Victory has a thousand fathers, but defeat is an orphan.” If the dollar’s slide is a defeat, then contrary to Kennedy’s wisdom, this defeat has a thousand fathers. Any number of observers now tell us that it was inevitable. One of my hobbies is to go back and see who saw it coming. Not from a pure forecasting perspective, but from an economic logic perspective. Who understood the key economic factors in advance and had the conviction to write them down? Marty Feldstein is one of those and this column presents my interpretation of the economic reasoning in his May 2007 paper.[1]

"Supplementing Social Security"

Rahm Emanuel has a proposal to increase personal savings:

Supplementing Social Security, by Rahm Emanuel, Commentary, WSJ: ...In the past two years, America's personal savings rate reached its lowest level since the Great Depression. And in comparison to other industrialized countries, the United States ranked second to last in personal savings.

Most people intuitively understand the importance of saving as a way to finance education or a dignified retirement, but the benefits to the overall economy are also important. An increase in savings enlarges the pool of capital...

Every American who works ought to have the chance to save. But today ... nearly half the work force ... lack[s] access to an employer-sponsored savings plan ... for retirement. At the same time, too many who have access to a savings plan contribute too little or don't participate... In addition, Americans don't start saving early enough. ...

Over the past 30 years, we have offered a blizzard of tax initiatives to encourage individuals to save for their retirement. .... Yet the national savings rate has plummeted. ...

In the last Congress, I proposed legislation that took a different approach. Instead of offering a new tax subsidy, my proposal helped companies automatically enroll employees in their 401(k) plans, rather than relying on workers to fill out the forms necessary to participate in a plan. ... If we make saving simple by limiting the amount of time, effort and decisions that people have to make, we can dramatically increase the number of people who save. In short, simplicity trumps choice.

Making saving easy is half the battle. The next step is to make saving universal. ... Republicans have long advanced the idea of personal accounts inside of Social Security. An accounts-based system that supplements, not supplants, Social Security can work. Democrats have argued that 401(k)s and personal savings are important supplements to Social Security, but we should ensure that fees are low and that lower-income Americans have the same opportunity to save that upper-income Americans enjoy. ...

I believe we should create Universal Savings Accounts. Like 401(k)s, the accounts would supplement Social Security. Employers and employees would contribute 1% of paychecks on a tax-deductible basis. Additional contributions could be made to the accounts at the discretion of the company or individual worker.

To ensure low management fees, these accounts would be managed by the private sector but overseen by a quasi-public board that would be given fiduciary responsibility for the types of investment options that workers could select. This system is used by the successful federal 401(k) program, or Thrift Savings Plan, where ... fees have averaged 30 cents for every $1,000 invested. By comparison, the typical mutual fund charges $15.50 per $1,000 invested. ...

To help achieve universal participation and simplicity, employers would automatically enroll their employees in these accounts, allowing employees to opt out if they ... did not want to participate. ... Since low-income workers have the hardest time saving for retirement, we should provide ... a federal tax credit that matches savings put into retirement accounts.

I believe that this type of approach ... is a necessary pre-condition to reforming Social Security. ... American people like the security that comes with Social Security. In order for us to tackle the problems of Social Security, Washington must provide solutions that make the American people feel more financially secure. If this anxiety is not addressed first, neither party will be given the opportunity to constructively address the challenges facing Social Security.

My approach protects the sanctity of the Social Security... It also expands individual savings opportunities outside of Social Security... Strengthening Social Security for the long term will take a sustained commitment to fiscal discipline and bipartisanship, commodities that can become scarce as we head into the presidential election season. But while Americans wait for long-term answers on Social Security, we should act now to give them more ways to start building retirement savings of their own.

I doubt this has much of a chance of going anywhere. I have no objection to the proposal, though the motivation used to sell the program - the implication that Social Security is headed for disaster if something isn't done - is overwrought. I also believe that these types of programs can easily turn from "add-ons" to "carve-outs" down the road which undermines their attractiveness, and I don't think these programs will increase savings as much as people predict once they become widespread and opting out is as simple as checking a box on a computer screen the first time finances get tight.

[Update: Andrew Samwick: A New Approach on Social Security Reform?]

Savings Glut or Money Glut?

Martin Wolf returns to the question of whether global imbalances and other features of the international economy are due to a “savings glut” or a “money glut”:

Villains and victims of global capital flows, by Martin Wolf, Commentary, Financial Times: Fast growth, huge current account “imbalances”, low real interest rates and risk spreads, subdued inflation and easy access to finance characterise the world economy. ...

The two interesting alternative explanations are the “savings glut” and the “money glut”. ... The “savings glut” hypothesis is associated with Ben Bernanke... A substantial excess of savings over investment  ... predominantly in China and Japan and the oil exporters ... has led to low global real interest rates and huge capital flows towards the world’s most creditworthy and willing borrowers, above all, US households. The short-term effect is an appreciation of real exchange rates and soaring current account deficits in destination countries. To sustain output in line with potential, domestic demand in those countries must also be substantially higher than gross domestic product. A country must choose fiscal and monetary policies that bring this result about.

Not only has the US absorbed 70 per cent of the rest of the world’s surplus capital, but consumption has accounted for 91 per cent of the increase in gross domestic product in this decade. Thus excess saving in one part of the world has driven excess consumption in another. ...

In the savings-glut world, governments are responsible for much of the capital outflow. This is either because domestic residents are not allowed to hold foreign assets (as in China) or because most of the export revenue accrues to governments (as in the oil exporters). Either way, governments end up with vast foreign currency assets as the counterpart of domestic excess savings.

In this world, the US is passive victim, excess savers are the villains and the Federal Reserve is the hero. In the money-glut world, however, the world’s savers are passive victims, profligate Americans are villains and the Federal Reserve is an anti-hero. In this world the US central bank is a serial bubble-blower...

The argument is that US monetary excess causes low nominal and, given subdued inflationary expectations, real interest rates. This causes rapid credit growth to consumers and a collapse in household savings. The excess spending floods across the frontiers, generating a huge trade deficit and a corresponding outflow of dollars.

The outflow weakens the dollar. Floating currencies are forced up to uncompetitive levels. But pegged currencies are kept down by open-ended foreign currency intervention. This leads to a massive accumulation of foreign currency reserves... It also creates difficulties with sterilising the impact on money supply and inflation.

In this view of the world economy, savings are not a driving force, as in the savings-glut hypothesis, but a passive result of excess money creation by the system’s hegemonic power. ... Governments of countries that possess the huge trade surpluses ... follow the fiscal and monetary policies that sustain the excess savings needed to curb excessive demand and inflation.

It is no surprise that the Federal Reserve is a believer in the savings-glut hypothesis. But many Asians blame their present predicament on “dollar hegemony”, which is the core of the “money-glut” hypothesis. The big questions, however, are which is true and whether it matters.

My answer ... is that the savings-glut hypothesis is truer, [and]... it does matter. If we live in the savings-glut world, the US current account deficit is protecting the world from deep recession. If we live in the money-glut world, that very same deficit is threatening the world with a dollar collapse and, ultimately, even a return of worldwide inflation.

The savings-glut view is far more comforting. Excess savers will learn to spend, in the end – sooner rather than later, if US spending were to weaken dramatically. But if we live in the money-glut world, the great gains in monetary stability of the past quarter century are at risk. Either way, the present world cannot continue indefinitely...

I will just add that it's possible to have both a high level of savings and a high level of liquidity growth at the same time.

FRB New York: How Worrisome Is a Negative Saving Rate?

Charles Steindel of the New York Fed asks if we should be worried by the negative personal saving rate. The NY Fed's summary gives his answer:

Charles Steindel explains that when the U.S. personal saving rate took a negative turn in second-quarter 2005, it raised concerns that Americans may have to curtail spending and accept a lower standard of living as they pay off rising debts.

However, the risks to household well-being may be overstated, says Steindel. Taking a closer look at saving trends, he argues that the surge in energy costs may have temporarily dampened saving, while the accounting of household income from stock holdings may be skewing saving estimates. In addition, broad measures of saving have remained positive, and household wealth—assets such as stocks and homes, less debt—is on the rise.

Still, Steindel cautions, low levels of household, private and especially national saving may take a toll over the long run and thus bear watching now.

Here's the entire report:

How Worrisome Is a Negative Saving Rate?, by Charles Steindel, Current Issues in Economics and Finance, May 2007  Volume 13, Number 4, FRB NY: The U.S. personal saving rate’s negative turn in 2005 has raised concerns that Americans may have to curtail their spending and accept a lower standard of living as they pay off rising debts. However, a closer look at saving trends suggests that the risks to household well-being are overstated.

We Need More Saving, But Not Right Now

Kash Mansori looks at personal income and saving and doesn't particularly like what he sees:

Personal Income and Spending, by Kash Mansori: Yesterday the BEA gave us some new data about personal income and spending for March of 2007. You can find the news release here, but what I want to focus on today are the reasons why I am worried about the prospects for consumption growth in the coming months.

Actually, my concerns can be summarized in a picture. The following graph shows the annual growth in consumption and in labor compensation, with both series adjusted for inflation using the PCE deflator. The red line then shows the savings rate for US households.

As I've discussed before, income growth for households that get their income through their labor has been sluggish during this economic recovery. Profits have been strong, and the income of people who get a lot of their income from their ownership of US corporations has done well...

Consumption growth, on the other hand, has been considerably and consistently stronger. How is that possible? There are three ways. First, households have spent an ever-growing portion of their income... so much so that by 2005 the savings rate actually turned consistently negative for the very first time. Second, some American households have enjoyed strong income growth from non-labor sources. I'm referring mostly to those profits that I mentioned above. Third, many households have used mortgage equity withdrawals to finance their consumption. ... But there are good reasons to guess that all three of these supports for consumption are running out.

The end of the housing boom and concomitant MEW phenomenon has been well documented by others (yes, I'm talking about Calculated Risk), so that source of money is drying up. Corporate profits have grown amazingly well in recent years, but probably can't continue that pace for much longer.

That leaves changes in the savings rate. But if anything, it is starting to seem like we are entering a phase where households will be more interested in moving their savings rate back toward zero, rather than allow it to become more negative. However, to bring the savings rate back toward zero (not to mention positive) households will have to allow several period elapse with rates of consumption growth below the rate of income growth.

Put it all together, and it seems quite likely to me that we're in for a period of slower consumption growth. And given the importance of consumption in the US's economic growth right now, that does not spell good news for the economy as a whole.

Worries about consumption didn't stop Ben Bernanke from calling for a higher savings rate. Here's Brad DeLong with details of his comments at the press conference after yesterday's speech:

Ben Bernanke Repudiates Bush Administration Deficit-Spending Fiscal Policy: From the Wall Street Journal's Washington Wire:

Washington Wire - WSJ.com: Bernanke Advocates More Saving: Brian Blackstone reports on Bernanke’s speech in Montana.

Federal Reserve Chairman Ben Bernanke said that U.S. lawmakers should aim economic policies at boosting U.S. savings, the lack of which is the primary source of the U.S. trade deficit. “Saving is critical,” Bernanke said in response to questions after a speech at Montana Tech. He said the trade deficit isn’t a reflection of the quality of U.S. goods and services but rather a result of the fact that the U.S. invests more than it saves and the rest of the world is a “net saver.”

“That saving is sloshing around the world,” Bernanke said, and is one reason that U.S. real long-term interest rates remain “very, very low.” “We won’t always have that,” Bernanke said in reference to the high rates of foreign saving that are coming into the U.S. That’s why it’s important for the U.S. to find ways to boost domestic saving, he said.

"That the U.S. invests more than it saves" is economist-speak for (a) American households and businesses don't save very much, and (b) the government spends a honking amount more than it collects in taxes. "Aiming economic policies at boosting U.S. savings" is economist-speak for (a) raising taxes, (b) cutting government spending, and (c) encouraging households to save more.

While all of those are healthy long-run developments, in the short-run they would slow output growth and this is not the time to be pushing output downward. This is the problem with cutting taxes instead of paying off debts when times are good.

William Poole: Changing World Demographics and Trade Imbalances

William Poole has a perspective that differs from most on global imbalances and the low personal saving rate in the U.S. After briefly reviewing seven explanations for global imbalances and differences in cross-country saving rates, he concludes there's little to worry about since most of it can be explained by the life-cycle hypothesis combined with demographic differences between countries. In fact, he will argue that "to a large extent, the current situation is not fundamentally an imbalance but rather a condition that is conducive to coping with the major demographic changes that are occurring throughout the world." I agree demographics is part of the explanation, but I'm not convinced it is as important as he has concluded, particularly if it means we become complacent about the potential for a sudden rebalancing of global accounts:

Changing World Demographics and Trade Imbalances, by William Poole, President, Federal Reserve Bank of St. Louis: ...The world economy is characterized by three highly unusual conditions. First, the capital flow into the United States from the rest of the world and accompanying rest-of-world current account surplus—the U.S. current account deficit—is very large and persistent. Second, the U.S. personal saving rate has been falling and past year became negative for the first time since 1933. Third, high-income countries are just now beginning a demographic transition in which the fraction of retired persons in the total population will rise to levels never before experienced. The idea I will explore with you is that these three conditions are connected; the first two, I believe, are to a considerable extent a consequence of the third.

Today’s topic on the connection between demographic changes and trade balances certainly is important. My analysis combines demographic and economics facts with economic theory to provide some insights into the connections between demographic changes and international trade. ... I especially want to highlight my unease with using the term “imbalances” to characterize the current situation. That term almost begs for a policy response—how can policymakers allow imbalances to persist? Unfortunately, policy responses could well involve damaging protectionist measures. I will argue that, to a large extent, the current situation is not fundamentally an imbalance but rather a condition that is conducive to coping with the major demographic changes that are occurring throughout the world...

Current Account Balances: Facts and Explanations Large and persistent current account surpluses and deficits are common in the global economy today, as illustrated in Figure 1 [note: in text links are to originals]. Since early 1998, the U.S. current account has trended downward, a fact that has attracted much attention not only in the United States but also throughout the world. As a share of U.S. GDP, the U.S. current account deficit has increased from roughly 2 percent to a level exceeding 6.5 percent in 2006. ... It is clear that today’s U.S. current account deficit substantially exceeds any other such deficits during the second half of the last century.

The United States, however, is not the only country with a current account deficit that is a relatively large share of its gross domestic product. In fact, certain European nations fit such a description. Figure 2 ... shows this ratio for the European Union and for selected European countries, some of which have current account deficits relative to GDP larger than the United States. For example, both Spain and Portugal have current account deficits that are close to 10 percent of GDP.

Are Inheritances Booming?

How much do baby-boomers stand to inherit from their parents and is it enough to make a material difference during their retirement years? Growth in the value of intergenerational asset transfer would, of course, provide additional assets that could be used in retirement, but unfortunately it looks like bequests won't provide much help to the typical household:

Boomers' big inheritance: Is it enough?, by Mark Trumbull, The Christian Science Monitor: The coming cycle of inheritances is billed as the greatest wealth transfer in US history. But don't expect it to finance the retirement of baby boomers or their children.

The reality, according to one new survey, is that when people do receive an inheritance, it's typically well under $100,000. And most people will receive no inheritance at all.

It's true that US households are richer than ever. ... But even as the pool of wealth has risen, the cost of retirement has been rising. Longer life spans, coupled with the rising cost of medical care, mean that many older Americans will use their wealth rather than pass it on to children.

"In many cases, because of increasing longevity ... it goes the other way. Instead of inheriting wealth the children wind up having to spend considerable wealth taking care of their parents," says Zvi Bodie, an expert on personal finance at Boston University. ...

Among the survey's findings:

•Only 24 percent of adult Americans expect to get an inheritance. And of those adults who have received an inheritance, the median amount received is $37,700.

•For working Americans over age 45 who have living parents, half are providing some assistance to their parents. Often it's nonfinancial – helping with chores and the like. But just as often these boomer kids are spending money on their parents.

•For workers over 45 who have grown children (over 25), one-fourth have a child living at home with them, and even more are providing financial support to those children – something most of them didn't expect to do.

The consequence: Less money is piling up in retirement funds than many workers wish. ...

This savings shortfall has gotten a good bit of media attention in recent years. But other news articles have drawn attention to a large pool of wealth that is expected to pass from older Americans – especially the World War II generation, to their offspring.

As far back as 1990, Fortune magazine talked about "the biggest intergenerational transfer of wealth in US history," in which middle-class Americans will "for the first time, inherit significant assets en masse." ...

Such reports have never promised that everyone will get an inheritance, let alone a large amount. ... America's wealth is concentrated heavily among the richest families.

"Only about 20 percent of households receive inheritances of any note," says Edward Wolff, a New York University economist who studies the distribution of wealth. "It may rise over time," he says, but "it's still going to be a minority of households." ...

Last year, an analysis done for AARP confirmed that, so far at least, boomers haven't reaped a mass windfall. Of those who have already received inheritances, the median amount as of 2004 totaled $64,000...

Shiller: Philanthropic Finance

Robert Shiller on how we might help the poor save more:

Laying a retirement lifeline for the poor, by Robert Shiller, Project Syndicate: ...Today's huge companies and the financial wizards who lead them -- or buy and sell them -- may be generous to their churches, favorite charities, and families and friends, but their professional lives are defined solely by the relentless pursuit of profits.

That perception may be largely true, but not entirely so. Consider Muhammad Yunus, who won the Nobel Peace Prize last October. His Grameen Bank ... has offered tiny loans to some of the poorest people in the world, helping to lift many borrowers out of poverty. The bank made a profit and grew over the years...

But was money Yunus' ultimate motive? In interviews, he reveals that he was actually motivated by a deep sympathy for the plight of the poor in his country. ... He tried to make a profit ... to prove the creditworthiness of these neglected people...

Paradoxically, while Yunus was pursuing profit, he was apparently not doing it for the money. ... Indeed, the history of financial institutions for low-income people is largely a history of philanthropic or idealistic movements...

China’s Huge Corporate Savings

Martin Wolf identifies the source of China's high savings rate - "huge corporate savings" - and he explains how both saving and the current account surplus can be reduced through government action:

Beijing should dip into China’s corporate bank, by Martin Wolf, Commentary, Financial Times: China represents something new in the history of the modern world: a developing country that has a vast global impact. This is why Hank Paulson, the US treasury secretary, has ... call[ed] for it to be a “responsible stakeholder”. But China will behave as the US wants only if it perceives that this is in its own interests. ...

At present, the most vexed issue between the two countries is the payments “imbalances”. Many in the US complain that China is manipulating its currency, to preserve excessive competitiveness. Certainly, China has a large current account surplus... No other country has as big a surplus.

The starting point then must be whether it makes sense for a poor country to export so much capital. The answer, I would argue, is “no”. But we must then also ask why China is running such large surpluses. ... Contrary to the conventional wisdom, the frugality of Chinese households is not the chief explanation for China’s surplus savings ..., the principal explanation is China’s huge corporate savings.

Between 2000 and 2005, ... some 70 per cent of the increase in gross savings was generated by the rising profitability of the corporate sector... Certainly, Chinese household savings are high by international standards ... an impressive 32 per cent of household disposable income in 2004. Nevertheless, household savings generate only a third of China’s overall savings. The undistributed profits of corporations are far more important. ...

Now consider the big question: does it make sense for China to save so much or, for that matter, to invest so much? After all, consumption – public and private – is no more than half of GDP, while private consumption is only 40 per cent of GDP. The answer, I suggest, is “no”. China can probably grow as fast with lower investment. It certainly does not need to accumulate more foreign assets. Higher consumption today would surely be desirable, particularly if it were consumption by – or on behalf of – the hundreds of millions of rural poor.

Moreover, as the World Bank has argued, the government has a simple way of achieving this outcome. It can ask the companies it notionally owns to pay dividends instead of keeping all the profits for themselves. Suppose it took 5 per cent of GDP from these companies in this way and spent this money on valuable social programmes: public health, for example. Other things being equal, the gross savings rate and current account surplus would fall. The welfare of the Chinese today would rise...

Now consider, instead, what might happen if gross investment were reduced, as those fearful of overheating and excessive investment suggest, but without cutting savings. Then the current account surplus would explode upwards. This would be globally disruptive and would bring no obvious benefit to China itself.

I would argue that the government needs not a policy to cut investment, but one to cut savings. Moreover, it can easily achieve this aim, because it is itself directly or indirectly responsible for the bulk of these savings. Above all, such a change is in the interest of the Chinese people. All the government needs do is exercise its rights of ownership. This, not a change in exchange-rate policy, is the most important step towards external adjustment...

An Interview with Martin Feldstein

This interview with Marty Feldstein covers its share of controversial topics. The interview is fairly long, so if you want to pick and choose the section headers are: The Art of Monetary Policy, Time Consistency in Fiscal Policy, Social Security Reform, European Social Insurance, European Union, The Return of Saving, The Economics of Health and Health Care, Executive Compensation, Supply-Side Economics, Tax Reform Panel, and The NBER:

Interview with Martin S. Feldstein, by Douglas Clement, Interview on July 10, The Region, September 2006: As a Harvard professor for nearly 40 years, Martin Feldstein has taught economics to thousands of young students, many of whom later became quite influential in their own right—as Treasury secretaries, presidential advisers, corporate leaders, even Fed governors.

As a policy adviser, he chaired the Council of Economic Advisers during the Reagan years, and landed on the cover of Time magazine in 1984 for his controversial opposition to a growing budget deficit. He has a lower profile in Washington these days but remains extremely influential, helping the current administration develop its tax cut initiatives, for instance.

And as president of the National Bureau of Economic Research, the nation's preeminent economics think tank, Feldstein has shaped the course of economic scholarship for almost three decades: identifying key issues, encouraging empirical research, creating opportunities for cooperation and disseminating working papers of leading economists long before they appear in academic journals.

But years from now it is likely that Feldstein will be best remembered as a prescient public citizen, a scholar who identified some of the most serious economic predicaments of our time, developed pragmatic solutions to those problems and then pressed policymakers—persistently—to implement them.

Social Security. Health insurance. Distortionary taxes. Unemployment insurance. The current account deficit. These are the issues that Feldstein has pushed to the forefront of popular and policy agendas decade after decade. Through a prolific stream of professional articles, newspaper columns and scholarly books, as well as frequent speeches and media interviews, he maintains a stark spotlight on crises that others try to ignore.

Educated at Harvard and then Oxford, Feldstein returned to Harvard as an assistant professor in 1967 and two years later became one of the youngest economists granted tenure by the university. In 1977, he won the John Bates Clark award as the best American economist under 40.

Numerous achievements and awards have followed, but Feldstein seems most gratified by close collaboration with colleagues. In the following interview, held during a break from the NBER's 2006 Summer Institute, a three-week gathering in Cambridge of about 1,400 economists, Feldstein notes that earlier in the day Paul Samuelson compared the Institute to Niels Bohr drawing atomic physicists to Copenhagen in the 1920s. “I thought that was a nice sentiment,” Feldstein comments quietly. His smile suggests that he could hardly conceive of higher praise.

Hi, My Name's Uncle Sam, and I'm a Debtaholic

Does the IMF have the ability to reduce the risk of a hard-landing posed by global imbalances?:

Can the IMF avert a global meltdown?, by Ken Rogoff, Project Syndicate: When world financial leaders convene in Singapore on Sept 18 for the joint World Bank/International Monetary Fund meetings, they must confront one singularly important question. Is there any way to coax the IMF's largest members, especially the United States and China, to help reduce the risks posed by the world's massive trade imbalances? ... Incredibly, the US is now soaking up roughly two-thirds of all global net saving, a situation without historical precedent.

While this borrowing binge might end smoothly, ... most world financial leaders are rightly worried... Indeed, if policymakers continue to sit on their hands, it is not hard to imagine a sharp global slowdown or even a devastating financial crisis. ...

Though the comparison is unfair, it is hard not to recall the old quip about the IMF's relative, the United Nations: When there is a dispute between two small nations, the UN steps in and the dispute disappears. When there is a dispute between a small nation and a large nation, the UN steps in and the small nation disappears. When there is a dispute between two large nations, the UN disappears.

Fortunately, the IMF is not yet in hiding, even if some big players really don't like what it has to say. The IMF's head, Rodrigo Rato of Spain, rightly insists that China, the US, Japan, Europe and the major oil exporters (now the world's biggest source of new capital) all take concrete steps towards alleviating the risk of a crisis. ...

[S]uch steps might include more exchange-rate flexibility in China, and ... a promise from the US to show greater commitment to fiscal restraint. Oil exporters could, in turn, promise to increase domestic consumption expenditure, which would boost imports.

Likewise, post-deflation Japan could promise never again to resort to massive intervention to stop its currency from appreciating. Europe, for its part, could agree not to shoot its recovery in the foot with ill-timed new taxes such as those that Germany is currently contemplating.

Will the IMF be successful in brokering a deal? The recent catastrophic collapse of global trade talks is not an encouraging harbinger. ... Fortunately for Mr Rato, addressing the global imbalances can be a win-win situation. The same proposed policies for closing global trade imbalances also, by and large, help address each country's domestic economic concerns.

For example, China needs a stronger exchange rate to help curb manic investment in its export sector, and thereby reduce the odds of a 1990s-style collapse. As for the US, a sharp hike in energy taxes on gasoline and other fossil fuels would not only help improve the government's balance sheet, but it would also be a way to start addressing global warming. What better way for new US Treasury Secretary Hank Paulson, a card-carrying environmentalist, to make a dramatic entrance onto the world policy stage? ...

If today's epic US borrowing does end in tears _ and if world leaders fail to help the IMF get the job done _ history will not treat them kindly. Instead, they will be blamed for not seeing an impending catastrophe that was staring them in the face.

Let's hope that on this occasion in international diplomacy, the only thing that disappears are the massive global trade imbalances, and not the leaders and institutions that are supposed to deal with them.

Interventions don't usually work. Those with addictions don't usually seek help until they "hit bottom." You can give them advice, explain rationally why they must change, and they may even nod their head and agree with you at some level. But until a crisis forces them to reconsider their ways, they will not hear the message and they will not take actions to forestall the hard-landing they are likely to have.

The IMF can keep nagging, but it's up to the countries involved to become serious about reform. While I hope that countries can be more rational in their approach than addicted individuals and avoid hitting bottom before reforming, so far it's difficult to detect a serious effort to address the underlying problems.

A Mystery

Nobody knows how many workers have accepted lower pay and benefits to keep their jobs:

Here, Take Back Some of My Pay, It’s Too Much, by Louis Uchitelle, NY Times: A number is missing. No one knows how many American workers have agreed to accept, however reluctantly, a cut in their wages or benefits or both in recent years.

The government tracks unemployment, job creation, layoffs, hours worked, average hourly pay and various other aspects of employment. But it doesn’t add up the number of people who have forfeited big chunks of their pay and benefits, and neither do unions or academic researchers.

That was true of layoffs until the early 1980’s, when the Rust Belt experience, and the devastating loss of blue-collar factory jobs, became a political issue. Congress, in response, asked the Bureau of Labor Statistics to count the layoffs in national surveys. ...

Keeping a job, but losing 15 or 20 percent of a salary and most of a pension, is a painful experience — and certainly not good for consumer spending. Still, there has not been enough political pressure for an accurate count of those affected. That is partly because many workers and unions have agreed to the concessions to preserve jobs.

Is there a ballpark number? Piecing together union data shows that it is probably above two million people in this decade alone. But no one knows. ... “None of our earnings surveys show these concessions,” said Thomas L. Nardone, an assistant commissioner at the Bureau of Labor Statistics. “We just don’t track that number.”

That would be useful to know. This is one of a series of short articles:

[F]ive New York Times reporters each set out to find one statistic, often overlooked, that said something important about the economic health of the American worker

Here's another entry on debt accumulation in recent years:

Borrowers We Be By, by Steven Greenhouse, NY Times: With their raises often lower than the inflation rate, millions of Americans have embraced the same strategy to maintain their living standards — borrowing and then borrowing some more.

As a result, debt payments now consume 19.4 percent of the income of the average American family, and 23 percent of the families in the bottom two-fifths of families by income devote at least 40 percent of their income to debt payments. With debt burdens so high, some economists fear a new wave of foreclosure and personal bankruptcies now that interest rates have climbed. ...

Household debt rose to 132 percent of disposable income last year, partly because many Americans have pushed their credit card debt to the max and because many, including many high-income Americans, have piled on the mortgage debt. Last year, for the first time since the Depression, the personal savings rate for the nation fell below zero, meaning that Americans are spending more than they are earning (and are saving no money on a net basis).

“There are really two types of households out there,” Mr. Zandi said. “High-income households have balance sheets about as good as I’ve ever seen, while lower-income households have balance sheets about as bad as I’ve ever seen them — complete tatters. These households are on the financial edge, and if there’s any slight disruption, like a car breaking down, it can be a real disaster for them financially.”

The Difference in Saving Rates between China and the U.S.

Robert Shiller explains the difference in saving rates between China and the U.S.:

Growth rate gulf result of opposite approach to saving, by Robert Shiller, Project Syndicate: The saving rate in China is the highest of any major country. China's gross saving rate ..., which includes both public and private saving, is around 50 percent.

By contrast, the saving rate in the United States is the lowest of any major country - roughly 10 percent of GDP. Differences in saving rates must be a major reason that China's annual economic growth rate is a full six percentage points higher than in the US. ... Unfortunately, explaining saving rates is not an exact science.

Ingrained habits probably explain more about China's saving rate. When incomes are growing rapidly, as they are in China, it is easier to save because people are not yet accustomed to a higher standard of living. They also tolerate enterprise or government policies that encourage high saving.

You Are Pre-Approved

According to the Fed, all those credit offers we get in the mail are good for us:

Love That Junk Mail, Washington Wire, by Christopher Conkey: Think most people hate all those pre-approved offers for credit that jam your mailbox every week? Think again.

The Federal Reserve Monday released results from consumer surveys it undertook in 2004 and 2005, and one of the more interesting findings relates to the way people view pre-approved credit offers. While more than half of cardholders said they receive six or more offers a week, and less than half of the people receiving such solicitations actually open them, more than 70% of cardholders said the government should not outlaw pre-approved offers. ...

The authors of the Fed report say there’s a good reason for this: All those annoying, mailbox-clogging offers are actually good for us. The “prevalence of prescreened solicitations is useful in disseminating pricing information and encouraging competitive conditions in markets for credit cards generally, even if only a small minority of recipients actually responds,” the report said.

The authors also found evidence of an “other guy effect”...: 85% said they think pre-approved offers cause other people to use more credit, but only 15% admitted doing so themselves.

I wonder if the U.S. government gets offers in the mail from Asian and oil producing countries telling them they are pre-approved for billions and billions more in credit. More seriously, I wonder to what extent the knowledge that credit is available quickly if and when you need it through the internet, pre-approved mail offers, or other means has reduced precautionary and other types of saving.

The Savings Glut

Was there and is there still a savings glut? Ben Bernanke thinks so. This is from David Altig at macroblog:

macroblog: The Chairman Speaks: The Savings Glut Persists: More from Chairman Bernanke's exchange with Senator Bennett during yesterday's testimony:

BENNETT: Do you still believe there's a global savings glut and that we can expect people to continue to want to put their money here?

BERNANKE: I think there still is a global savings glut. It may have moderated somewhat because of increased growth in some of our trading partners. But on the other hand, there's also been, of course, these large revenues that the oil producers are accumulating because of the high price of oil. They are not able to absorb - - use those revenues at home very quickly. So they are taking that money and putting it back into the global financial system. And so that's contributing to this overall global savings glut...

So I think there has been some change, but the broad idea that the global savings glut is out there I think is still valid.

Of what Mr. Bernanke speaks, in pictures:

Still looking pretty gluttish.  The data, if you are interested:

Download savings_glut.ppt

UPDATE: Shame on me.  I should have added this part of the discussion:

BENNETT: So you're suggesting that foreign investment in the United States is not about to dry up at any point soon?

BERNANKE: I don't think it's going to dry up. I do think that over a period of time we should become more reliant on our own saving and reduce the current account deficit.

Emphasis added.

Like the word bubble, glut has a new meaning. To me, the term glut conveys a disequilibrium condition -- a time when aggregate demand is deficient, there is involuntary unemployment, goods are piling up on store shelves (that's the glut, lots of goods, nobody to buy them), and for some reason prices aren't moving to clear the market (e.g. the Malthus-Say debate where Malthus said, essentially, that gluts are caused by high profits leading to excessive capital accumulation and a mismatch between saving and investment; Say responded by saying that gluts were impossible because supply creates its own demand, i.e. with Say's law).

So every time I hear savings glut I have to remind myself of how the term is being used. I don't think Bernanke means that the supply of savings exceeds the demand for savings at the current interest rate even though I'm certain he is well aware of this interpretation of a glut. He means increases in supply are holding interest rates down as they move to clear the market. Thus, a glut simply means a large supply driving down equilibrium prices, not a disequilibrium condition where supply exceeds demand.

A Nickel Saved Through Opt-Out and Matching Grants is a Nickel the Government Won't Have to Give You

Having used Hal Varian's little blue book as one of my micro texts in graduate school, I have no doubt about his skills as a microeconomist. My complaint about this article examining policies to encourage low-income Americans to save more is that those skills are not used to identify the market failure the policies address.

To say, as in the opening line, that "Economists are in almost universal agreement that Americans save too little," and to follow with suggestions that the government intervene in the marketplace implies these markets do not produce the right incentives to save, that the market outcome is one of too little saving. The article does mention different savings rates as an explanation for differences in asset accumulation over time, but that is a behavioral statement, not a specific market failure. If we don't know what the problem is, how will we know what solution is best? My preference is to start by identifying the problem, then proceeding to find a solution. But whatever the problem is, the argument Varian makes is that these programs appear to work:

Looking for the Incentives That Will Prompt Americans to Save More, by Hal Varian, Economic Scene, NY Times: Economists are in almost universal agreement that Americans save too little, and several policies have been proposed with the goal of encouraging them to save more.

The Bush administration favors increasing contribution limits on tax-deferred savings accounts like I.R.A.'s. Critics argue that there would be little impact on total savings ... since wealthy households would simply transfer assets from taxable accounts to tax-sheltered accounts.

Leaving aside the behavior of high-income households, responsible members of both parties recognize that providing better incentives to low-income people is the most challenging problem. How can we get this group to save more?

It is possible for low- and middle-income groups to increase savings. After a detailed examination of the financial circumstances of people close to retirement, two economists, Stephen F. Venti ... and David A. Wise ..., concluded that the primary reason for differences in retirement assets was differences in propensities to save. ...

One promising proposal has been to set ... 401(k) plans so that employees are automatically enrolled in an appropriate plan unless they explicitly choose otherwise. ...[T]his simple policy increases participation rates dramatically.

Another suggestion is to provide matching grants to low-income individuals. ...("Saving Incentives for Low- and Middle-Income Families: Evidence From a Field Experiment With H&R Block"; ... nontechnical summary ...) In this experiment, ... low- and middle-income families ... were offered a 20 percent match on their contributions to an I.R.A., a 50 percent match or no match at all...

Only 3 percent of the individuals who had no match — the control group — contributed to an I.R.A. But 8 percent of those with a 20 percent match rate contributed, and 14 percent of those with a 50 percent match contributed. The amount contributed was four times as much as the control group for the 20 percent match rate and seven times as much for the 50 percent match rate. ... And most people stuck with their plans: four months after the initial contribution, over 90 percent of the individuals still kept the money in their I.R.A.'s.

These effects are far larger than those of the Saver's Credit, an existing program that provides a tax credit based on the amount of tax-deferred savings. The problem is that a tax credit is useful only if you pay taxes, and many low-income individuals have little or no tax liability after other deductions and credits are applied. Furthermore, the Saver's Credit is complicated and hard to understand. A matching contribution to a savings program is much easier to comprehend. ...

As the authors put it, "Taken together, our results suggest that the combination of a clear and understandable match for saving, easily accessible savings vehicles, the opportunity to use part of an income tax refund to save, and professional assistance could generate a significant increase in contributions to retirement accounts, including among middle- and low-income households."

Matching grants also have a long and venerable history as an American institution. They were invented by none other than Benjamin Franklin in conjunction with his fund-raising efforts for the Pennsylvania Hospital, the first public hospital in America, established in 1751.

Franklin persuaded the legislature to participate by indicating that it would receive "the credit of being charitable without the expense" and explained to the donors that "every man's contribution would be doubled." No doubt the sage of Philadelphia would heartily approve of his innovation being used to encourage the virtue of thrift.

Consumer Debt

These writers from Fred Alger Management argue that the current level of consumer debt is not a problem:

Alive and well under a mountain of debt, by Zachary Karabelland and Dan Chung, Commentary, Financial Times: Remember the scene in Monty Python and the Holy Grail where two men push a wheelbarrow through a plague-afflicted village shouting: “Bring out your dead”? A family heaves a body on to the pile, whereupon it lifts his head and says: “But I’m not dead yet!” One man whacks him with a cudgel and says: “Now you are.” That is the perfect metaphor for the American consumer on the one hand and strategists, commentators and economists on the other. They keep trying to bury the consumer under a mountain of debt, even though he is alive and kicking.

There is an understandable cultural prejudice against debt. For most of history, the risks outweighed the costs. If you calculated wrongly, you did not just go bankrupt: you lost your business, home and possessions. ... Low interest rates, securitisation and bankruptcy law have changed the nature of debt.

Our prejudice against debt no longer makes sense. In March, Federal Reserve chairman Ben Bernanke said as much when he suggested that the substitution of mortgage debt for credit card and automobile debt had been a rational decision by consumers to shift leverage into lower-rate obligations. But his assessment is at odds with attitudes on Main Street and Wall Street, especially in light of global agitation over inflation and excess liquidity.

There is no denying that the absolute amount of consumer debt is higher than ever. ...  a total of $11,500bn. Big numbers, yes, and big numbers are easily turned into a harbinger of crisis. But take the financial net worth of US households (which excludes the value of homes): $26,500bn, an all-time high. With home value included, that rises to $52,000bn – more than four-and-a-half times household debt. ...

Even with the Fed tightening, the absolute level of rates is low by historical standards, so low that for all the refinancing and home-equity extraction we have seen, we can still see more. The average mortgage rate for a 15-year loan is around 6 per cent. In 2000, it was 7.72 per cent. Even though conventional wisdom says that consumers are tapped out, they can continue to use their homes as piggy banks. Even if rates go up another 50 basis points, it is likely that consumers will extract hundreds of billions of dollars in cash-out refinancing this year.

Furthermore, the amount that households must spend to service their debts is manageable. That should be the central concern: not how much debt, but whether it is affordable. In 2001, households spent 12.9 per cent of income to service their debts; by the end of 2005, that had risen to nearly 14 per cent. Again, the key issue is rates: if rates are at or near a peak, debt-financed spending can continue. If not, we will face a credit crunch, especially since average incomes are barely rising.

Anyone who defends current [debt] levels risks being labelled as blind not only to structural imbalances but to the struggles faced by families who are taking on debt to meet basic obligations such as homes, medical costs and education. We are not making a judgment about the wisdom of individual consumers, about the struggles they face or about an American culture that overemphasises consumption and encourages excessive spending. We are making a structural argument that the economy can sustain far higher levels of consumer debt than in the past. Even if more individuals face a credit squeeze, the system overall is in no jeopardy.

In addition, many consumers may be using debt more wisely than commentators give them credit for. The increasing array of financial instruments means that people can take on more debt when they are young and their career outlooks are improving. ...

Stripped of its stigma, debt is a neutral tool. Used prudently, it generates economic activity; taken on foolishly, it is a recipe for problems. The question is: what is the tipping point? Prudence, say the sceptics, dictates cutting back now. But is that prudence, or fear? ...

In a world of low rates and less structural risk, the definition of moderation – and risk – must change. The fear debt arouses once protected people from stupid decisions, but today it impedes a rational assessment of costs and benefits. ...

Recent evidence indicates:

"On average, debt burdens appear to be at manageable levels, and delinquency rates on consumer loans and home mortgages have been low," Mr. Bernanke said...

While consumers are managing their finances fairly well so far, I am not as willing as the authors to declare household debt a worry free zone, particularly in the event of a sudden downturn in the economy.

"I'd Gladly Pay You Tuesday for a Hamburger Today"

Are we being Wimpy when we worry about household and government debt? This post looks at U.S. indebtedness today and some of the associated risks, and the post that follows examines how attitudes toward debt have changed over time:

Reasons to Worry, by Niall Ferguson, NY Times Magazine: ...[A] question for economists is whether the United States is capable of evolving out of its present excessive indebtedness. Or could the global economic environment change so drastically as to threaten ... decline relative to smaller, more dynamic economies?...

Since becoming president, George Bush has presided over one of the steepest ... rises ever in the federal debt. The gross federal debt now exceeds $8.3 trillion. There are three reasons for the post-2000 increase: reduced revenue during the 2001 recession, generous tax cuts for higher income groups and increased expenditures not only on warfare abroad but also on welfare at home. And if projections from the Congressional Budget Office turn out to be correct, we are just a decade away from a $12.8 trillion debt — more than double what it was when Bush took office.

Big public debts are not always bad, to be sure. It could be argued that in his first term Bush wisely used fiscal policy to boost aggregate demand and counter the impact of the dot-com bust. Public borrowing also allows "tax smoothing" by spreading out over time the cost of big one-off expenses like wars, three of which the United States has fought since 1999.

On the other hand, by requiring larger interest payments, big public debts devour revenue that could be spent on other programs. They may crowd out private investment by pushing up long-term interest rates. They may also have a regressive distributional impact, transferring economic resources from taxpayers to bondholders or from future generations to the present generation. ...

Was There a Golden Age of Thrift?

Does the high indebtedness of households signal a moral decline relative to previous generations? Not according to this look at how consumer indebtedness has changed over time:

The American Way of Debt, by Jackson Lears, NY Times: Americans are awash in red ink. Consumer indebtedness is soaring, the savings rate is down to zero and people are filing for bankruptcy at record rates. To many observers, these are symptoms of cultural decline, from sturdy thrift to flabby self-gratification...

The equation of debt and decline assumes that once upon a time Americans lived within their means and saved for what they bought. This is fantasy: there never was a golden age of thrift. Debt has always played an important role in Americans' lives — not merely as a means of instant gratification but also as a strategy for survival and a tool for economic advance.

Yet our moral traditions have concealed this complexity. "Owe no man anything," St. Paul warned... Indebtedness signified a sin against the Protestant ethic of self-control; it also threatened the ideal of independent manhood that underwrote the founders' vision... The indebted man "must smile on those he hates, he must extend his hand where he would strike, he must speak pleasantly with a curse in his throat," a Harper's contributor wrote in 1894. "He wears dependence like a yoke." Benjamin Franklin coined similar lessons..: "The Borrower Is a Slave to the Lender." "Be frugal and free." The link with lost freedom was more than metaphorical: you could still be imprisoned for debt in many places (including New York City) down to the early 1900's.

Still, the case against debt was more principled than practical. Every generation of moralists imagined the same fall... In their novel "The Gilded Age" (1873), Mark Twain and Charles Dudley Warner mourned the disappearance of the antebellum "horror of debt"...  In 1924, the editor of The Saturday Evening Post complained that "the firmly rooted aversion to debt ... has almost completely evaporated." In 1958, John Kenneth Galbraith noticed that "there has been an inexplicable but very real retreat from the Puritan canon that required an individual to save first and enjoy later."

In fact, debt is as American as cherry pie. ... Among ... rural folk, through most of the 19th century, cash was scarce, and country-store ledgers carried local peoples' debts for years, sometimes forever. Factory workers and laborers used debt to make ends meet, resorting to pawnshops, loan sharks, relatives and friends. Even moralists admitted distinctions between good ("productive") debt and bad ("consumptive") debt. ...

After 1900, the proliferation of mass-marketed products encouraged a more open tolerance for consumer debt. By the 1920's, millions of middle-class Americans bought durable goods on time payments — sewing machines, washing machines, radios, automobiles, houses. Lenders acquired legitimacy...

Indebtedness could discipline workers, keeping them at routinized jobs in factories and offices, graying but in harness, meeting payments regularly. Good consumers would be good producers. The economist who proposed this idea was Simon Nelson Patten, in "The New Basis of Civilization" (1907). ... He predicted that workers' desires for things would not undermine their capacity for disciplined achievement, as generations of moralists had claimed...

Patten was onto something. The disciplining power of debt was undeniable. Even during the Depression, while Americans cut back on new borrowing, they also denied themselves food and clothing to avoid repossession of refrigerators or real estate. ... In 1932, a Harper's contributor observed that the middle-class homeowner "no longer has possessions but only obligations." This homeowner did not exactly represent an ethos of self-gratification.

The true fulfillment of Patten's vision depended on an economically secure working population. These conditions awaited the rise of strong industrial unions and the comparative prosperity of the post-World War II era. The acquisition of appliances, cars and houses was often financed on the installment plan or with the assistance of government agencies like the Federal Housing Administration. Thanks largely to union power, more fortunate workers could depend on steady wages that allowed them to pay off big-ticket items over time. Patten would have been pleased.

The upward spiral of earning and spending survived until the 1970's, when the midcentury ideal of corporate citizenship evaporated in the harsher climate of renewed international competition. Fearing foreign rivals, American business ended its implicit social contract with unions by seeking cheap labor in overseas markets.

During the 1980's, ... Reagan's rhetorical refusal of limits combined with the deregulation of the lending industry to detach dreams of luxury from previous constraints. As money worship mounted, job security disappeared and inequalities widened, pundits spoke of a new Gilded Age.

By the 1990's, bloated icons of affluence proliferated: the gargantuan pseudo-military vehicle, the 10,000-square-foot hacienda. A bigger standard package of household goods demanded deeper debt and accelerated the pace of the consumer treadmill. No one wanted to look like a "loser."

But for many borrowers, debt has not been just about keeping up appearances. Less-affluent Americans have resorted to borrowing for groceries as well as cars. Public policies have intensified their plight. The freezing of the minimum wage, the tightening of unemployment insurance and workmen's compensation programs, the shifting of the tax burden from the rich to the rest — these changes have starved public services while leaving ordinary Americans more dependent than ever on debt. One of the most consistent statistical findings of recent years is that about half of all personal bankruptcies have been caused by medical bills. Whatever else our current indebtedness may signify, it is hardly a riot of hedonism.

Hitting It Big for Retirement

Given the amount of tax revenue that states raise regressively through legalized gambling such as lotteries and video poker, I thought this was an interesting table. It compares the expected earnings in constant dollars from investing various amounts in an S&P 500 index fund versus using the money to play the lottery. The reason for looking at this is that, according to the Tax Foundation article:

A recent survey conducted by Opinion Research Corporation ... and ... reported in a MarketWatch article, found that Americans are, for the most part, pessimistic about their ability to save for retirement—so pessimistic, in fact, that 21 percent of respondents said playing the lottery is “the most practical strategy for accumulating several hundred thousand dollars” for retirement.

The MarketWatch article continues saying "...with 38% of those who earn less than $25,000 pointing to the lottery as a solution." This table looks at the expected losses from pursuing such a strategy over a 40 year time period:

Table 1. Rate of Return on Lottery vs. Rate of Return on Stocks over a Forty-Year Period in 2006 Dollars

Average Amount Spent or Invested per Month	Total Spent or Invested over 40 Years	Expected. Return from Lottery(a)	Expected Return from S&P 500	Increased Retirement Savings from Investing Rather than Playing Lottery
$1	$761.37	$178.14	$1,622.17	$1,444.03
$5	$3,806.85	$890.72	$8,110.85	$7,220.13
$10	$7,613.70	$1,781.44	$16,221.69	$14,440.26
$25	$19,034.26	$4,453.59	$40,554.23	$36,100.64
$50	$38,068.52	$8,907.18	$81,108.46	$72,201.29
$100	$76,137.03	$17,814.35	$162,216.92	$144,402.57
$150	$114,205.55	$26,721.53	$243,325.39	$216,603.86
$200	$152,274.07	$35,628.70	$324,433.85	$288,805.14
$250	$190,342.59	$44,535.88	$405,542.31	$361,006.43
$300	$228,411.10	$53,443.05	$486,650.77	$433,207.72

Note: Calculations assume a constant 2 percent inflation rate, 7 percent return on S&P 500 average, and monthly compounding. Lottery spending is not adjusted for life cycle or income cycle.
(a) Based on a 53% cumulative payout rate for all lotteries from 1964 through 2003. ... [Source: Tax Foundation]

Interesting difference in expected returns, but I'm not convinced that people would invest much more if lotteries and other forms of legalized gambling did not exist. The more important concern is, of course, the highly regressive nature of this form of "voluntary" taxation that provides false hope for those in dire economic conditions. Lotteries are easy politically, but they impose large and inequitable costs on some segments of the population. The state should get out of the gambling business and raise taxes by some other means. Nobody has to pay a dollar more and no services have to be cut, just levy the taxes directly so that the tax burden is clear rather than having it obscured through lotteries and other devices.

Interest Rates and Saving

Martin Feldstein says:

The Federal Reserve has reversed its low interest rate policy... It will only be a matter of time until the household saving rate is at least back to the 2.4 per cent level of 2002.

I was curious about this so I plotted the 3-month T-Bill rate against the personal saving rate since 1980 to get a rough idea of the association between the two variables:

Click to enlarge

High Household Saving in China

In China, factors such as underdeveloped financial markets and fear of large future expenditures due to both economic insecurity and expected inflation cause households to accumulate large savings balances:

High prices are eroding consumer confidence, by Zhang Shunyi, Shanghai Daily: Mounting household savings in China's banks is not necessarily the good thing it seems. According to the People's Bank of China, domestic individual bank deposits... hit 14 trillion yuan (US$1.72 trillion) by the end of 2005. The record-breaking amount of deposits indicates that the Chinese people are much wealthier on the whole. However, rapid accumulation of deposits also shows that people are reluctant to spend as the consumption rate has been on the decline for five consecutive years...

Last year, loans issued by China's banks only accounted for 53 percent of the total money they collected. Part of the other 47 percent was stored in the PBOC as the excess reserve. To make a comparison, loans took up 91 percent of the total a decade ago... Basically, there are two ways to deal with the problem of excessive household savings. One is to further encourage consumer spending thus reduce the deposits. The other, as was mentioned above, is to find more channels, which are profitable and safe, to digest the deposits. Easier said than done.

Both of these two measures require fundamental adjustments in the system of social and banking mechanism. The importance of results brought by these changes can never be understated - it links directly with economic stability. Why are people reluctant to spend? Chinese people are well-known for the habit of hoarding up valuable things. But under the current climate, worry about high prices is perhaps the most cited reason.

"What many people see is the rising price of seeing a doctor or studying in a good school. That makes them feel less safe," said Sun Lijian, a professor at Fudan University's School of Economics. According to a recent survey from Horizon Research, expensive medical services and changes in the pension scheme are listed among the top concerns that trouble Chinese people. If people lose their job, suddenly become ill, want to buy an apartment or hope to deliver better education to their kids, they have to splash out a great deal of money on those things.

The housing price provides a case in point. Even in second-tier cities such as Hangzhou, Wenzhou or Ningbo, people have to save their disposable income for 27 years to buy an 80-square-meter apartment on average. And compared with 1999, the cost of fees for a college student has jumped from 51,000 yuan to 131,000 yuan...

Reducing interest rates to induce people to spend money is difficult. "The PBOC is very prudent about making any more changes to the interest rate. It is nearly impossible to reduce the rate when it already stands at such low a level," said Wu. Perhaps the most important thing to do is to give people confidence about their basic life.

In addition to the measures to enhance economic security, it is also important to develop the financial services industry so that it doesn't take decades of saving to, for example, buy an apartment. In order to reduce its dependence on exports and aid in global rebalancing, China must increase domestic consumption. The "fundamental adjustments in the system of social and banking mechanism" won't happen overnight supporting Bernanke's view that it could be as long as ten years before imbalances are resolved.

The Bigger the Oil Price Shock, the Harder We'll Fall

Martin Feldstein is worried that if oil prices go up again and depress economic activity, a falling saving rate won't to bail us out this time:

America will fall harder if oil prices rise, by Martin Feldstein, Commentary, Financial Times: The price of imported oil in the US doubled between summer 2003 and summer 2005, reducing consumers’ purchasing power by more than 1 per cent of gross domestic product. Nevertheless, the economic slowdown that was widely expected never occurred. Consumers kept spending and businesses kept investing. ... The continued strong growth contrasts sharply with the economic weakness that occurred after almost every previous significant rise in the oil price. How do we explain this remarkable difference? And what are the implications for the likely response to a future rise in oil prices?

The key to the economy’s strength in 2004 and 2005 was that household saving declined dramatically while the price of oil rose. ... This shift ...in the annual rate of saving far outstripped the fall in income caused by the higher cost of oil. This fall in saving allowed households to raise consumption spending on non-oil goods and services while paying for the higher cost of imported oil. The primary cause of this dramatic shift was the fall in interest rates and the resulting rise in mortgage refinancing. Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumer durables, home improvements and the like. The lower monthly payments permitted a higher level of sustained spending on all non-durable categories. ...

The faster increase in consumer spending caused businesses to invest more and raised the rate of growth of GDP. Faster GDP growth caused an accelerated rise in employment and a fall in the rate of unemployment. Mortgage interest rates were falling because the Federal Reserve’s fear of deflation had caused it to lower the short-term federal funds rate ... to the extremely low level of 1.0 per cent in 2003 and to leave it there in the first half of 2004 before beginning a very gradual process of rate increases. ... The lower mortgage rates induced refinancing and the subsequent gradual rise in rates induced additional refinancing by homeowners who wanted to borrow before rates rose further.

The powerful effect of mortgage refinancing on consumer spending was a very happy coincidence for the American economy at a time when oil prices were depressing consumers’ real incomes. If oil prices were to rise again in 2006 or 2007, the adverse effect on consumers’ real incomes would not be offset by increased mortgage refinancing. Mortgage refinancing has now peaked and is declining. The Federal Reserve is raising interest rates again to counter the inflationary pressures that remain from the rise in energy costs. And individuals no longer have the large amounts of household equity against which to borrow.

A rise in the oil price could happen again at any time. There is little spare capacity in global oil production and oil demand is rising rapidly in China and other Asian countries. A shock that reduced the production or shipping of oil could drive its price sharply higher. Speculative forces could compound this problem. The US was lucky after 2003 to escape the contractionary effect of an oil price rise even without an explicit change in monetary or fiscal policy. It would not be so lucky if a big oil price increase happened again now.

I don't always agree with Feldstein, but I do here.

Impatience and Savings

I haven't followed this literature closely, but it looks interesting and many of the papers noted below have been posted here ( 1, 2, and 3, the last has links to seven papers). It's an analysis of savings behavior starting from a biological perspective. On another note, I'm very literally off to grandma's house in a few minutes - lots of rivers to pass over and lots of woods to pass through - so I won't be able to post or comment until tonight:

Impatience and Savings, NBER Reporter: Research Summary Fall 2005, by David Laibson: When making decisions with immediate consequences, economic actors typically display a high degree of impatience. Consumers choose immediate pleasures instead of waiting a few days for much larger rewards. Consumers want "instant gratification." However, people do not behave impatiently when they make decisions for the future. Few people plan to break their diets next week. Instead, people tend to splurge today and vow to exercise/diet/save tomorrow. From today's viewpoint, people prefer to act impatiently right now but to act patiently later.

Data from neuroscience experiments provide a potential explanation for these observations: short-run decisions engage different brain systems from long-run decisions. Using functional magnetic resonance imaging (fMRI), Samuel McClure, George Loewenstein, Jonathan D. Cohen, and I have shown that decisions that involve at least some short-run tradeoffs recruit both analytic and emotional brain systems, whereas decisions that only involve long-run tradeoffs primarily recruit analytic brain systems. These findings suggest that people pursue instant gratification because the emotional brain system - the limbic system - values immediate rewards but only weakly responds to delayed rewards.

"The Rabbit is Indeed in the Middle of the Python"

The theme of the next few posts is global imbalances, so let's start things off with two articles about China. First, The Financial Times wonders if China's rapidly aging population will cause slower economic growth in the future:

Why China stands to grow old before it gets rich, by David Willetts, Commentary, Financial Times: ...One reason for China’s stellar growth is that it is at a demographic sweet-spot. The massive reduction in infant mortality achieved by China’s barefoot doctors in the 1960s and 1970s is now yielding a surge of young workers – an extra 10m working-age adults per year. China’s challenge now is just to absorb them into the labour force. ... There are few pensioners and there are not many children either. The rabbit is indeed in the middle of the python. As early as 2015, China’s working age population will actually start falling. By 2040, today’s young workers will be pensioners – in fact the world’s second largest population, after India, will be Chinese pensioners. ... The desperate rush for economic growth is fuelled by fears that China could grow old before it grows rich. ... Imposing the one-child policy ... is having an extraordinary effect. If you can have only one child it becomes highly desirable to have a boy. The rule is not as strictly enforced as it was, but you can now see its effect on the second child, which in the eyes of many Chinese really is the last chance to have a boy. For every 100 female second children, there are 152 males. Overall, there are now about 120 boys for every 100 girls in China. ... China is going to have to attract large-scale female immigration or many of its young men will leave. ... So China is going to be full of old people and rather earnest, frustrated young men. It will be one of the most dramatic and unusual demographic changes the world will have seen for a very long time, and Chinese leaders now would do well to plan for such a future.

Next The Los Angeles Times discusses how economic insecurity, lack of an effective social security system, underdeveloped financial and mortgage markets, and high educational costs cause the high savings rate in China:

Anxiety Drives Chinese Fixation on Frugality, by Don Lee, LA Times: ...China's economic reforms have vastly improved living standards, but the last two decades also have seen a dismantling of the socialist "iron rice bowl" that provided basic health and welfare from cradle to grave. The result is that many Chinese today feel more insecure about their future than their parents' generation did. Chinese families are saving about half of their income. ... [M]ost experts expect China's savings rate to stay high for years to come because of the need to prepare for a large dependent elderly population. ... China, like other nations in East Asia, has a long tradition of thrift. Analysts say it may be linked to Confucian values that encourage thrift and production rather than consumption. China's propensity to save also reflects its agrarian society, where people face more risks of fluctuating incomes and their long work hours leave them with little leisure time to consume. ... pensions, for those who have them, tend to be modest. China's healthcare system is broken; insurance is inadequate for most everybody. Many employers in China don't provide insurance ... In the event of a serious ailment, ... "even an entire life savings may not be enough. So they dare not spend." Zhuo Yunbao recently had a scare when his father was hospitalized with a stroke. He says his father may need a pacemaker, but that's not covered by the state insurance for the elderly. The family is saving for more than a rainy day. They want to buy a car. A few years from now, Zhuo says, maybe they'll look at moving into a bigger home. ... More than anything else, though, the Zhuos are squirreling away for their son's education. ... Like many young Chinese parents, the Zhuos want to send their son abroad for college. They have their sights on England or the U.S., where four years of tuition could reach $125,000. The family has saved a little more than 10% of that. "We have a long way to go," Zhuo says.

Guy de Jonquières: Asia's Missing Investment

Asia has plenty of saving. So why is investment so low?   For Guy de Jonquirères, the answer lies with excessive regulation and weak competition:

Asia’s missing investment, by Guy de Jonquières, Financial Times: International investors ... cannot get enough of the great Asian growth story. ... Yet Asian companies appear curiously reticent about joining the party. Eight years after Asia’s financial crisis and with solid growth forecast ... one would expect businesses to be making big capital outlays ... However, with the exception of China, they have not done so. ... Whatever the reason for the caution, it is not lack of funds. ... private sector saving..., according to the latest available data, is higher than before the crisis. ... Some critics blame Asia for generating excessive current account surpluses by saving too much. However, the International Monetary Fund argues in a recent report that the real culprit is an “investment drought”(Asia Pacific Regional Outlook, September 2005). ...[Why have] they ... held back. ... One reason could be the shift of manufacturing to China ... However, studies have found little evidence that China has diverted foreign direct investment away from its neighbours. Another theory is that official data exaggerate companies’ financial strength by ignoring many smaller ones that are still struggling ... Equally, an overhang of unsold property, built before the crisis, may have delayed a recovery in construction. But not all countries experienced property bubbles during the 1990s. Finally, business confidence may have been dampened since the crisis by setbacks such as the severe acute respiratory syndrome scare, the 2001 US growth slowdown and cyclical downturns in the global electronics industry. But all this is conjecture. The IMF confesses it is puzzled. Private economists are also stumped.

Most, nonetheless, still believe investment will recover. There are some positive signs. ... But more investment is not necessarily better: witness China’s vast glut of manufacturing capacity. If the rest of Asia simply reverts to its old habit of investing for export-led growth, it will further depress product prices and fuel western protectionism. To be sustainable, its growth must be based on stronger domestic demand. But ... except in China and India, households are already saving less and borrowing more, so cannot be expected to boost consumption much further. As for governments, ... their finances allow only limited room prudently to increase spending. There is another option. Much of Asia is crying out for better transport, healthcare, education, power and water. The World Bank and the Asian Development Bank say $1,000bn needs to be spent on infrastructure. Governments cannot provide it all. But more imaginative approaches to privatisation could help fill the gap and create new opportunities for private investment. They might also reduce scope for corruption ... Second, there is huge untapped potential to boost wealth creation by stimulating domestic markets. The prime candidates are services, which in much of Asia are shackled by weak competition and over-regulation. Setting them free would yield big productivity and efficiency gains....[S]uch reforms will be essential ... if Asia is to keep growing. Its past development has relied heavily on harnessing abundant cheap labour and capital to producing for export markets. ... How Asia solves its investment puzzle will be critical to shaping its future development. When the region’s next investment wave arrives, it should be judged not just by its weight but by its quality.

While excessive government regulation and intervention is certainly to be avoided, I think there is more to recovery from the investment drought than "imaginative approaches to privatisation" and "Setting them free." For those interested in more on this issue, see [1], [2], [3], [4], [5], and [6].

The Bank of Canada's David Dodge on Solving Global Imbalances

David Dodge, Governor of the Bank of Canada, discusses global imbalances in The Financial Times and how their resolution is a shared worldwide responsibility, but I thought I'd go back to a more extended version of his remarks from a September 9 speech.  Among the issues cited as necessary to avoid a worldwide recession are the need for countries to adopt fiscal, labor market, financial market, and social safety net reform.  Fiscal reform will prepare countries for coming demographic challenges and also allow fiscal policy to be used, if necessary, to combat deficient aggregate demand.  The other reforms are intended to increase worldwide flexibility to respond quickly and efficiently to economic shocks and avoid prolonged recessions.  In addition, the reforms are intended to stimulate aggregate demand by reducing the need for saving.  His point that all countries have a role to play in the rebalancing effort is worth emphasizing since much of the debate on this issue has involved trying to identify a particular country or policy that explains the current situation when a combination of factors is at work:

The Evolution and Resolution of Global Imbalances, Remarks by David Dodge, Governor of the Bank of Canada: ...Today, I will talk about two types of global economic imbalances. The first relates to ... savings and investment ... being distributed across countries in an increasingly uneven way. The second is the possibility that, over the next couple of decades, the global economy might face a protracted period in which desired savings exceed planned investment, partly because of demographic trends. If economic policy-makers do not take appropriate measures quickly enough, there is even a risk—albeit a small one—that the world economy could end up with ... widespread demand deficiency and a persistent deflationary gap. ...Geographical imbalances are not necessarily a bad thing, nor are the large capital flows that they generate. Indeed, ... world financial markets ... allow savers in one country to lend to borrowers in another. Such a process leads to higher global growth ... If markets ... operate without interference, imbalances can resolve themselves in a reasonably smooth manner. But in the absence of appropriately functioning market mechanisms, there is a greater risk that the correction will be abrupt and disorderly. ... a disorderly correction might also lead governments to adopt wrong-headed protectionist measures... [R]egardless of how these imbalances are resolved, it is clear that the resolution will require greater net national savings in the United States. Investment in the U.S. economy will need more financing from domestic sources ... This implies an increase in net U.S. exports and a decrease in net exports elsewhere in the world, as well as an increase in domestic demand in other countries. Exchange rate movements have an important role to play in this regard, ... efforts by some countries to slow or prevent required adjustments by pegging exchange rates are ... counterproductive. ... such policies raise the risk of a much larger and more disorderly correction in the future, as well as an outbreak of protectionism... Within the United States, higher interest rates can be expected to lead to increased savings. Authorities could also encourage greater national savings with a tighter fiscal policy. And they could implement ... reforms to encourage national savings through taxation ... and other measures. But if the United States alone were to act to resolve its imbalance ... it would leave the global economy with much weaker aggregate demand. And so a number of other countries must focus on stimulating domestic demand. ... So, how can we stimulate domestic demand outside the United States? ... Structural reforms to remove market rigidities are important for most of us. Many need to improve or develop their financial system ... For some, the development of social safety nets would be helpful, so citizens don't feel the need to hold excessive precautionary savings. And for a few, more stimulative fiscal policy would be helpful.

...[T]he second type of imbalance ... will be posed by evolving economic and demographic realities. ... Let me ... expand on this risk by highlighting two trends that will be important over the next decade or two. First, ... Asia's share of the world economy will continue to grow. ... Asian nations have traditionally had a higher rate of savings ... so, all other things being equal, we can expect that global desired savings will rise. But all other things are not equal. The second trend that we can expect is higher desired savings in most OECD economies as the baby-boom generation prepares for retirement. Taken together, these two trends can certainly be expected to lead to a higher level of global desired savings. So it is critical for policy-makers to act now, so there can be an increase in demand and investment to compensate... To deal with this expected slower growth in domestic demand, ... what can policy-makers do to support  ... private consumption, government spending, and investment? In terms of investment, ...  First, one might look to governments to provide an expansionary fiscal policy. ... Certainly, the economies of emerging Asia have the scope to support demand with fiscal policy. But in North America, Europe, and Japan the scope for fiscal policy ... appears to be very limited ... But if there is one thing that all governments can do to stimulate demand, it is to have appropriate structural policies ... We all need to take steps to improve the flexibility of our labour markets ... We also need to recognize that well-functioning credit markets are extremely important ... The improvement of labour and financial market policies is particularly important in Europe. In emerging Asia, improving income-security policies is essential ...In closing, ... I'm not saying that a disorderly correction to global imbalances is certain to happen. Nor am I saying that the global economy is inevitably headed for a deflationary shortfall in demand. What I am saying is that, as prudent policy-makers, we must not rely on good fortune to help us muddle through...

Australian Reserve Bank Governor: Global Imbalances not Caused by U.S.

This is a discussion by I.J. Macfarlane, Governor of the Reserve bank of Australia, on global trade imbalances. What's different about this discussion? He does not believe global imbalances are caused by developments within U.S. He also has five key developments (empirical facts) that any theory of the current account imbalance must explain. His contention is that a story with the U.S. as the cause of global imbalances cannot explain all five of these developments. At the end he asks, and answers, the question of whether he lets the U.S. off too easily. Finally, he is dismissive of excess liquidity stories.  It's a bit long, but not quite as long as it appears as it includes graphs, footnotes, and references:

What are the Global Imbalances?, I.J. Macfarlane, Governor, Talk to Economic Society of Australia Dinner, Melbourne - 28 September 2005:

I was told to remove this speech by the media office of the Reserve Bank of Australia (RBA).  I am used to policies such as these:

Unless otherwise specified on this web site, reproduction         of any Federal Reserve Bank of San Francisco Information contained herein may be made without limitation as to number, provided however, that it is not distributed for the purpose of private gain and it is appropriately credited to the Federal Reserve Bank of San Francisco.

Unfortunately, the RBA is more restrictive. Apologies to readers - the speech is still available in the link above.

Will Changes in Consumption, Investment, the Social Safety Net, or the Exchange Rate Reduce Saving in China Anytime Soon?

The Economist reports on China's high saving rate, nerly 50% of GDP, and the prospects for change in the near future.  While saving has slowed recently, investment has slowed even faster leading to a more rapid accumulation of saving.  There are solutions to the saving imbalance in China, Chinese consumers could increase consumption and reduce saving, domestic investment could pick up, social safety nets could be improved, or the yuan could be revalued, but according to this analysis, the prospects for a quick adjustment in any of these factors do not look promising:

The frugal giant, by Minton Beddoes, The Economist: ...[T]he world ... is still waiting for a big Chinese consumption boom. ... the Chinese are spending a lot more than they used to. ... But Chinese saving is growing even more rapidly. Since 2000, the country's overall saving rate-already the world's highest by far-has risen sharply, to nearly 50% of GDP (see chart). Even though China is investing at the staggering rate of 46% of GDP, it is still running a net saving surplus, and that surplus is still growing... and shows no signs of stopping.

 

...China's capacity for thrift has long perplexed economists... What is going on? Household saving is the easiest to make sense of. First, Chinese households have not changed their consumption patterns fast enough to keep up with the huge rise in their incomes. ... a large part of China's growing income has been going to the relatively small share of the population living in coastal areas. Richer people save more than poorer ones. ... Moreover, the one-child policy has made it harder for people to rely on their children as a source of support in old age, further encouraging thrift. ...  A further incentive to saving is the weakness of social safety nets. Under the old economic regime many Chinese workers could count on health and pension benefits from state enterprises (the "iron rice bowl"). No longer. ... Pension coverage is low ... Health care is also getting more expensive. ... Education, too, requires deep pockets ... The relative lack of credit is another factor... consumer credit is still in its infancy. ... Like the Japanese in the 1960s, the Chinese need to save a lot because they find it hard to borrow.

       

And save a lot they do. Chinese household saving, at around 25% of disposable income, is astonishingly high ... But ... they were not responsible for the sharp rise in national thrift since 2000. ...China's household saving rate has been more or less steady since 2000 (see chart). The recent rise in national saving was led by ... the corporate sector. ... China's firms are now bigger savers than its households. But unlike their peers in the rest of the world, they are investing their surpluses... That splurge may well prove unsustainable. Profit growth has slowed sharply over the past year ... Slower profit growth means less corporate saving, but investment seems to be slowing even faster ... the pace of China's investment is likely to fall over the medium term...

What happens to China's national saving surplus will depend on whether China's households will save less and spend more, thus becoming the engine of the domestic economy. The example of Japan is sobering. Although Japanese households now save much less than they used to, their country never really made the shift from export-led to consumer-led growth. ... China, however, is different in important ways. Its economy is already much more open than Japan's ever was. ... And ... China seems to be shifting away from an undervalued currency far more quickly than Japan did. ... but this is likely to take several years. Although American policymakers may be clamouring for a rapid rise in the yuan, there is no sign in Beijing that the government plans anything of the sort. ... A government that depends on rapid economic growth to legitimise itself will not want to risk instability with a sudden rise in the currency, so a much stronger yuan seems an unlikely route to a quick reduction in China's saving surpluses. ... Redirecting an economy as big as China's towards domestic consumption takes time. China's saving surpluses will not last forever, but nor will they disappear overnight. And trying to move too fast can be disastrous, as the mess in Asia's other emerging markets shows.