Why the fall in the savings rate is not meaningless
Yesterday, I wrote a post which examined three different reasons the savings rate in the US could have been falling over the last year. Rebecca Wilder thinks this is a meaningless exercise:
Edward Harrison at Credit Writedowns is theorizing why the saving rate is falling when it should be rising, as households scram to deleverage their balance sheets. My reaction to this is twofold: first this is a meaningless exercise; but second, and worse yet, there’s likely something very "unhealthy" going on here.
Meaningless: The BEA conducts a comprehensive revision of the NIPA tables every five years. The saving rate is usually revised upward, and by a fair amount, as was the case for most of the 2000s.
So in "roughly" 5 years from 2009 (it’s not uniformly 5 years between each revision), you will see a higher saving rate than you do today. As I said in July, the
"BEA has "found" that households have been in fact saving roughly 1% more of their disposable income per quarter since 1995, 0.9% per quarter in 2008."
They will "find" it again.
The thing is that we are not looking at savings rate levels but changes in those levels. I have seen the NIPA revisions and I even mentioned the fact that some pundits feel the savings rates will be revised upward:
Note that some pundits believe the data are inaccurate and that the decline has been nowhere as large as the data now indicate. Time will tell.
I reckon that when the revision do come in, regardless of whether they are revised higher, they will show that the savings rate did in fact still dip precipitously from mid-2009. That IS indeed what we saw in the revisions in 2004 after interest rates were dropped as indicated in Wilder’s charts. The question is why.
Understanding why savings rates are dropping in the midst of a still severe economic shock, weak credit growth and sustained high levels of unemployment will tell you something about the durability of the policies used to goose GDP over the past three quarters. So, this is not meaningless in the least.
I have proffered three potential reasons why. Wilder offers another: the black market for labour:
With an employment-to-population ratio a shocking 58.5% in February (it was 63.4% as recently as March 2007), there’s got to be a growing supply of labor that is "working under the table" just to get by. This non-market income would flow through the spending accounts but not the income accounts. Therefore, you have official consumption going up with official income (doesn’t include non-market income) stalling, which reduces the saving rate.
Implicitly, what Wilder is suggesting is that the savings rate actually is not dropping, that what we will see later is that a revised savings rate will be relatively flat from 2009 to 2010. Obviously, I disagree. But as I stated above, time will tell.
However, more important in my analysis is the conclusions about stimulus one could reach. If I am right about asset prices being responsible for a downshift in the reported savings rate, we shall see that the withdrawal of stimulus leads to a fall in asset prices and a relapse into recession.
Moreover, in a post on the recent personal income data, I wrote:
The challenge the US faces is how to maintain consumption growth in the face of continuing pressure on income. Businesses are enjoying a huge resurgence in profit and this has contributed to their savings and low debt levels. Yet, households remain indebted. Moreover, after the 2009 stimulus shot in the arm, disposable personal income is not going anywhere.
Unless US policymakers solve this problem – the divergence in the benefits of economic policy for business and households, consumption growth will have to slow. If consumption does slow and asset prices stall, the US will be headed back into recession.
If you understand the financial sector balances approach, the increase in the government’s deficit must be balanced by a concomitant increase in the combined private sector and capital account surplus. Put simply, if the government goes into greater deficit, this increase must be balanced by an increased surplus of private sector savings or capital account inflows.
Clearly the aim of the deficits should be to increase household sector savings. But what I am stating rather clearly I believe is that this is NOT the aim of the deficits in the least. Nor is it the aim of monetary policy. Instead we have:
an industrial economic policy in the US which is predicated simultaneously on suppression of domestic wage growth and on consumption growth in order to boost corporate profits and increase asset prices.
In fact, the Federal Reserve’s low interest rates discourages household sector savings and promotes the accumulation of debt. The government may expand in order to induce an increase in net private sector savings, but fiscal expansion is a blunt instrument. The government cannot (in the short-term) determine where capital account or private sector surplus is directed or held. Right now, government deficit spending is increasing business savings and not household savings.
Moreover, having low nominal rates skews investment toward payoffs with long lead times (think telecom infrastructure or tech in the 1990s and property in the 2000s). Longer-term, much of this shows up as malinvestment. You can’t expect an adequate long-term return on capital when average nominal rates across the business cycle are low.
What will happen instead is that firms like pension companies that have actuarial assumptions that are pegged to higher nominal returns will reach for return creating a misallocation of investment capital to riskier enterprises. Much of this will turn out to be a dead weight loss to the economy. You see this already with the returns in high yield bonds and the prevalence of payment-in-kind securities in leveraged finance deals to boost returns.
This is just an asset-based economic model predicated on ever-increasing asset prices. There is certainly something "unhealthy" going on here. Low rates are no panacea for slow economic growth. Nor is deficit spending in the absence of a purge of accumulated malinvestment. Trying to increase demand to meet excess supply simply doesn’t work, especially in an aging population. Just ask the Japanese.
A reader tipped me off to a recent FT article by former Daiwa Securities Chief Economist Tadashi Nakamae, "How Japan could lead the way back to durable growth," which points to excess capacity as a reason for Japan’s continued malaise. He makes good points that I have made about malinvestment previously. I especially like it when Nakamae says:
demand-side fiscal and monetary policies have served only to delay the much-needed elimination of excess capacity.
That is exactly what I have been saying. However, I do have concerns that his ‘solution’ of firing people en masse as he suggests leads to a deflationary spiral. More likely, it is better to allow marginal firms to fail.
As Wilder correctly states at the end of her piece, it is an increase in household income which will truly increase demand – sustainably. Wilder gives one example of how to increase income via a jobs program, something I have also broached and called unemployment insurance for the 21st century. See The consumption response to income changes from Vox for another take.
Also see Nakamae’s prescient remarks from January 2008 on the reluctance to write down debt in the banking crisis in the FT’s Japan’s salutary tale in banking crises.
The saving rate paradox – Rebecca Wilder
Edward, I fear you’re exactly right.
You rightly point to the Japanese experience and with evidence mounting all around us that it’s in fact happening here, we still fail to acknowledge its existence. Part galling, part saddening.
Nakamae’s comment is mind-numbing when you think about how long the Japanese have suffered from being held captive to an economy held in suspended animation (from an asset price perspective) and an overcapacity issue in another.
Great post, though.
Nice assessment. However, on the accounting identities there is something many folks don’t seem to be considering.
The savings-investment identity:
INVESTMENT = GOVT SAVE + PRIVATE SAVE + NET FOREIGN INV
As you pointed out, to maintain aggregate demand, the government must run a deficit to allow the private sector to increase savings. However, as the private sector attempts to raise its savings over time and reducing consumption, the likelihood is that it will not quite be enough to fill the deficit void left by the government. In such a case, INVESTMENT must fall, which implies reduced living standards and less innovation. An increasing share of our income must be used to pay for yesteryear’s wasteful expenditures and speculative debt-financing in areas like real estate.
There are no good options once the nation is over indebted to the extent we find ourselves today. The Fed can attempt to devalue and expand credit, but that is difficult to do from here. The fiscal side can expand, but that cannot continue indefinitely, and ultimately real interest rates rise to force discipline.
The third option is the natural cleansing effects of debt liquidation, which hopefully can be done orderly and over time through default, restructuring, and the painful process of increased savings for debt paydown. It is the disorderly debt-liquidation process that creates crashes. Unfortunately, we’re still trying to do #1 and #2, which makes the already bad perdicament worse.
The question to me is: when and how are we going to cure the excesses and imbalances? All at once or a little at a time? At the current rate, there will probably be a nasty day of reckoning.
The government adjustments used to account for “black market” income (via previous surveys or something of the sort) are unlikely sufficient. The employment to population ratio has fallen precipitously back to levels not seen since the early 1980’s, when the labor force mix was very, very different. As an example, home sales are improving in California, for example, – foreclosures are the type that need work; and it is all too easy to pay (less) cash to workers and be done with it. Not measured (for now); but like you say, time will tell. We will see in the revisions.
I would add a comment about Japan – the leverage comparison, and consequently the appropriate fiscal response, is not directly comparable. In Japan est. 1990’s, the real leverage problem was weighted on the non-financial business sector, and to a much lesser degree, the households. In contrast, the private-sector US debt burden now is heavily weighted on the household sector, and less so on the non-financial firms (the chart in this post https://www.newsneconomics.com/2009/12/us-flow-of-funds-wealth-recovery-fully.html is a bit dated, but speaks to my point).
I view a demand-driven FISCAL policy response as appropriate in the US. The unemployment insurance and government transfer programs are serving as a net backstop for both spending and saving (even with the unintended consequences of longer duration of unemployment). More is needed, and I agree with your take: it needs to be better directed to facilitate the desired saving rate.
To be sure, the banking system is consolidating too slowly and there is a large deadweight loss as a result. But GM (the auto industry) does not tell the whole story. Much of our economy is built upon the service industry; and if you are telling me that retail is too big, then okay – but I haven’t heard of bailouts going to Ann Taylor (I do not shop there). There is certainly a consolidation in Boston (where I live) underway – Newbury Street, the hot place to shop with stores the likes of Burberry or Brooks Brothers, now has at least 3 second-hand stores and several store fronts sitting idle. I just hope that the drop in capacity in the sectors that are “allowed to consolidate” does not overshoot, as the sectors being propped up by the government (the financial sector) sluggishly downsize.
I see that the government is not efficient in its allocation of resources (Cash for Clunkers, TARP, or GM), so a massive tax break (given the smaller multipliers than direct government spending) and a jobs bill that works are in order!
Thank you for your comments, Rebecca Wilder
Yes, Americans are going into debt. Housing gig is up. Just recently I heard on the news that wages have decreased, not increased. The stimulus, and debt are obviously the culprit that I can point to, and I don’t see no data regarding the black market labor is the reason. Prices have to go down, so consumers can purchase things. You are correct about the monetary policy. The fiscal policy is there to drive spending, not savings, or even purging of malinvestments. I think that is quite obvious. Government spending is simply the fill the hole in consumer spending. The government wants the private sector to spend, not save. That’s what tax rebates, and tax credits are all about. The more the government spends, the more it crowds out the private sector. Tax cuts aren’t really meaningful when the government is running a large deficit. The economic imbalance in the USA is just as bad, if not worse than yesteryear, and this economic imbalance will prove unsustainable, or very volatile as time goes. The policies are perpetuating that.
Government spending does not “crowd out” private sector spending. The government “spends” by crediting bank accounts, the effect of which is to DRIVE DOWN rates, not increase them. Bond sales are required if the government spending takes rates below the Fed’s reserve rate target.
You’re working with a “loanable funds” model which was discredited around 70 years ago.
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