Here is further proof why those large fiscal deficits only serve to weaken economic growth.Since August 2007, the US economy has experienced two fiscal stimulus packages. The first was under Bush in April 2008; the second was under Obama in January 2009. The idea behind both packages was the same. Cut taxes and increase government spending in order to put money in consumer's pockets, who would then go out and buy stuff and sustain economic activity.
However, US consumers have other ideas. Instead of spending, they have decided to save. The US savings rate has jumped to almost 7 percent. Back in the bubble days, US household savings rate had fallen to almost zero.
The jump in savings is even more surprising given that US interest rates are close to zero. US Households must be very keen to save.
Both stimulus packages can be clearly identified in the US savings rate. The first peak is Bush. The recent upswing in savings, which starts in 2009, is due to Obama.
So why are US consumers suddenly saving? Everyone knows that the current deficit is unsustainable and therefore taxes will soon have to increase dramatically. The current increase in household incomes are temporary and they will soon fall when higher taxes kick in. Consumers are trying to stabilize their income over time and building up their assets in anticipation of the future federal clawback.
Economists call this Ricardian equivalence, but that is just a fancy name for a simple idea. Consumers instinctively know that a deficit must be paid back and that fiscal stimulus packages never work.
The irony is that we have known this since the days of David Ricardo, who first explained this principle. He lived during the 19th century. So why are we having to learn this lesson again?
19 comments:
Anything similar for blighty?
Anything similar for blighty?
I am generally a fan of your blog - but this time I think you have it wrong. I can't believe that Joe public has the slightest notion of tax rises to come. Apart form anything the budget may get fixed by spending cuts rather than tax rises.
I have written in detail about why people are saving more here.
Mick,
I think households respond to incentives and signals. Right now, fiscal policy in the UK and US is screaming out huge tax hikes in the future.
Everyone knows it. Ask your gran or a taxi driver. They will put you right.
Thanks for the kind words and I regularly read your blog.
alice
Ok, deal... I shall do a survey and get back to you :-)
Mick,
I am always surprised about how people process economic information. My starting position is that people are not stupid. To coin an old cliche, no one walks past a five quid note on the street.
However, governments often distort incentives and this is why we often see people behaving oddly.
Trust me, ordinary people are picking up that public finances are in a total mess.
Alice
I agree that most people (70%?) probably are aware that the finances are in a mess, but this does not necessary mean that those people are thinking that taxes will rise. Don't forget that most people know next to nothing about economics. Many will think things line "those tories will be in soon, and they're always on about cutting taxes" or "no political party would dare raise taxes, so they'll cut back on spending instead". If the Ricardian equivalence effect exists, I suggest that in the current situation its effect is tiny compared to the multiple other reasons to spend less and save more detailed here and here.
1.
Alice wrote "Instead of spending, they have decided to spend. " That surely should be "save."?
2.
Mick The laffer curve and international competition says state spending has to be cut as we are peaking on the Laffer curve.
anti citizen one
Thanks for picking that error up.
Alice
"Consumers instinctively know that a deficit must be paid back and that fiscal stimulus packages never work."
More nonsense. People aren't saving because they are worried about taxes. They are saving because 1) there is a recession going on and they are afraid of losing their jobs, and 2) $14T of their net worth evaporated between 2007Q2 and 2009Q1 and they are afraid they will never be able to retire.
Beyond that, the idea that all these savers have deciphered the budget and worked future taxes into their planning is just silly. If people were good at planning for the future we wouldn't be in this mess in the first place. They also would have noticed years ago that federal debt was going up and started saving. There's no evidence of that.
As usual, your graph fails to provide proper context. The US savings rate has been far, far too low for years. Reversion to some acceptable rate was inevitable.
http://research.stlouisfed.org/fred2/series/PSAVERT
Alice said "I think households respond to incentives and signals".
This sounds very similar to the kind of statement the Stand-up Economist satirises in his routine on Mankiw's ten principles of economics (on Net).Highly recommended.(Yes,he gets laughs analysing an Economics textbook.)
If by savings one includes "paying off debt" then the second stimulus did exactly what it was designed to do - it was designed to make some of that iffy credit card debt on the banks' books look a little better. In no way are people saving to cover their next tax bill. People are getting letters in the mail saying their CC interest rate is going from 7% to 21% - that is the incentive they are responding to.
Here is a different take on the savings rate in the US. This is probably closer to the truth of the matter.
Such a nice informative topic and graphically representation show how it effected by the economical level.
I agree with the last anonymous poster that it is not a case of people saving more, but of cutting down on their debts, as their economic prospects worsen, and to avoid usurious interest rates now being charged by the ever-more-greedy (or is that desperate?) banks.
I have to agree with other anon, most people don't understand the link between government debt and higher taxes. They still think if it is supplied by the government it is "free".
Just look at the Labour party election campaigns, they have been based on the idea people are morons for years and it has worked out pretty well for them so far.
People are stupid and selfish... or we wouldn't have New Labour in power now.
Even though they knew that Blair had lied about Iraq, they still voted for him back in 2005... because they "felt wealthy" 'cos their houses had doubled in value and were that naive they thought it would go on and on... free money !
Even now, New Labour are popular because they spend and the Tories talk about tax hikes and spending cuts.
Any thinking person will realise that this spending splurge is just not real - it is yet MORE borrowed money that will have to be paid back one day - through either tax hikes, spending cuts (which means job and/or pay cuts) or more than likey - both!
People don't seem to be able to put 2 and 2 together - they don't seem to understand that the UK does not earn the lifestyles we have had and that the "boom" was just a mirage - a mad spending spree using someone else's money.
Reckon there will be one hell of a reality check after the next general election... whoever gets in !!!
I would suggest that the savings increase has been caused by fear of the future. I'm sure taxes play some role in that, but I would think that fear of losing your job would be a bigger component.
And it also speaks of low inflation expectations. Weak pound, higher commodities, still we expect deflation, or is that just because house prices are going down?
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