After many of us have been arguing for some time that an increase in the U.S. personal saving rate was key for promoting long-run growth and reducing the trade deficit, the American consumer finally obliged with a 0.5% drop in consumption spending in August. But analysts such as Angry Bear and Macroblog see this as an ominous development. So which is right– is more saving a good thing or a bad thing for the economy?
Macroeconomists sometimes distinguish between the short-run and the long-run consequences of a rise in the personal saving rate. In the short run, a key determinant of national income can be the total demand for goods and services, and consumption spending is the biggest single factor in this. A lower level of consumption spending acts to reduce current income through this effect. In the long run, a key determinant of national income is national wealth, which is only acquired over time through national saving. A lower level of consumption spending means higher national saving, and therefore raises future income through the second effect.
Which effect dominates at any given time depends in part on the suddenness with which spending patterns change. Ideally we would like to see a gradual and predictable rise in saving, for which businesses have plenty of time to shift resources out of production of goods and services no longer desired and into production of more investment goods. If consumption spending instead drops precipitously and without warning, firms are left with idle resources and undesired inventories, and aggregate demand rather than productive capacity becomes the factor limiting total output. Production cutbacks and layoffs precipitate further spending cuts and the economy can move into recession.
How could lower consumption spending actually lead to an increase in future income through the long-run effects? Lower spending by consumers generally would include lower spending on imported goods, which would directly reduce the current account deficit and the borrowing from other countries that finances the current account deficit. Owing less money to foreigners in the future means more future income left for Americans for our own future consumption and investment. This is just the manifestation at the national level of something we all understand from personal experience– if you save more today, that means you consume less today but can consume more in the future.
Lower current consumption raises national wealth in the form of less foreign indebtedness through this direct mechanism. It would raise national wealth in the form of a higher capital stock more indirectly, primarily through an effect on interest rates. A higher rate of saving would mean a lower real interest rate which would promote additional investment spending. Again if the changes come slowly and predictably, this higher investment spending can replace the reduced consumption spending so that total demand need not fall even though consumers are spending less.
Another actor in this latter story is of course the U.S. Federal Reserve. The Fed has the ability to control the nominal interest rate. But over a longer time horizon, it has limited ability to control the real interest rate, which is primarily determined by private saving and investment decisions. Just as businesses can have a hard time responding to changes in consumption spending that come very rapidly, the Fed has a hard time sorting out their implications for the long-run real interest rate. If over the short run the Fed prevents the fall in real interest rates that would be the natural economic response to the fall in consumption spending, the investment demand won’t be there to replace the lost consumption spending.
Is the actual drop in consumption spending of $47 billion enough to qualify as a large, sudden change that’s a cause for concern, or is it the small, gradual change that would be a good thing? The answer depends on what happens next. If this turns out to be all the drop in consumption that there is, then things will probably be OK and this would eventually prove to be a favorable development. But Barry Ritholtz sees the August consumption figures as the harbinger of a major shift. If he’s right, will businesses and the Fed recognize it in time? Probably not.
What makes the key issue here — is this a large, sudden change or is it the small, gradual one — so difficult to discern will be the Fog of Katrina.
August data was pre-hurricane(s), and September numbers will be skewed, and mostly written off.
By the time we get as clearer read — October data released in November — we may have been driving down the wrong road or quite a while . . .
… more savings, or “less negative?”
We’d had a negative savings rate for the last three months. I can’t find my “three month” link, but this story is similar to the one I saw previously:
http://www.philly.com/mld/inquirer/business/12767425.htm
Now, are you saying it is dangerous to get out of this dangerous condition too quickly?
My gut instinct is that a negative savings rate on a national scale is bad, and the sooner it is fixed, the better.
I guess I’m not alone, in that my gut instinct is echoed at The Guardian:
“The International Monetary Fund made it clear last week that it saw the world’s largest economy as an accident waiting to happen. The US could not continue to live beyond its means indefinitely, and there were only two ways to deal with the unsustainable imbalances in the global economy: the nice way or the nasty way.”
I suppose there is some economic difference between a nation living beyond its means, and everyone in a nation living beyond their means, but I think we’re in the same ballpark.
http://www.guardian.co.uk/business/story/0,3604,1579037,00.html
Kash of Angrybear saw this is bad news. I’m still hoping for more investment demand.
Has anybody bothered to look at a graph of PCE. Not the month to month percentage change, but the actual amount. I suspect that what happened was a significant increase in June and July because cars were on sale and then a decrease back toward the longer term trend once everyone got what they wanted.
We also took a hit from Katrina although there should be a larger impact in September.
Ill worry about this if October and November show decreases.
Scott, I know cars were on sale, and that this factor is listed in many reports … but were these really the best car prices since 1934?
Note:
“The government recently reported that the national savings rate in June fell to zero for only the second time since it started making a monthly calculation in 1959. Last year, the annual savings rate was at its lowest point since 1934.”
http://www.kansascity.com/mld/kansascity/business/12749595.htm
If household expenditures and obligations drop over the next year, what incentive does this provide for seeking reevaluation of the exchange rates and mechanisms that govern such?
Drop in consumer spending volume is not the same as a drop of the share of consumption in the national economy. We know that while consumption volume is at present down so is the household savings rate. This doesn’t mean that there is much more room for new investments.
I think that discussing long run effects of lower consumption in a situation where we have just one months statistics of lower consumption sounds pretty desperate. Well, for all that macroeconomic training in the mainstream spirit that I have received the situation really is desperate. And we could make it more so by adding that there is no law that says that imports should fall more or at all when overall consumption demand decreases. It usually does but it is not necessarily so. Consumer stress may lead to increasing imports of cheaper foreign goods and this may lead to decreasing domestic investments. The decrease of imports of capital goods and raw materials may or may not offset the increasing imports of consumer goods.
The real question here is how the US got to this desperate situation. How come the interest rates have not risen and exchange rates have not corrected the trade deficit? How come the ultra-easy monetary policy has not caused more inflation? How come everything is working just fine in spite of the econometric models showing that this should not be possible. Everybody from IMF and World Bank to the best professors of macroeconomics have been warning for the hard landing for some time now. Everybody agrees that in the long run this is unsustainable, but as Keynes said, in the long run we are all dead.
This question is of course crucial for the economic policy choices. If the conventional wisdom has not worked by now why should the policy recommendations based on it work in the future? If we are not ready to join the neo-Austrian school of Arnold Schwarzenegger there must be some other explanations and the economic policy must be based on these.
The most straightforward explanation is that the Asian money flows are so huge that they override the rules of conventional ecnomics. These flows are not really generated by the US monetary policy but the US monetary policy has been made possible by them. So the engine of all this is on the other side of the Pacific. Things are really different this time. But only geographically so the old macroeconomic laws are really still working.
Does this mean that the US monetary policy doesn’t matter any more? Or that it is futile to even try to do something? Possibly not but the starting point should be adapting to the new situation, not trying to control it. There is a tectonic shift in the world economy and it is no point in resisting that. The British have long time ago adapted to their changed role as an ex-center of the financial and industrial world. So must the Americans.
104th Carnival of the Capitalists
2 years ago Jay and Rob created the Carnival of the Capitalists. This edition celebrates the end of the 2nd year and looks forward to the Anniversary editions from the founders the next two weeks. In that time there
if consumers begin to save it will be very interesting to see how this plays out on the treasury yield curve…….i think the reaction will be counterintuitive and will lead to higher rates in the belly of the curve. most treasury market professionals attribute the much lower than expected rates through this tightening cycle on the strength of demand from foreign central banks which have presumably aquired those dollars through multiple sales of widgets to american consumers……as american consumers reduce purchases of widgets less dollars accumulate overseas and consequently demand for treasuries in belly of curve should fall accordingly,bringing with it higher rates in the midst of an economic slowdown?soft patch…jjj
Citizenry is supposed to save more…
Citizenry is supposed to spend more…
If wages go up Alan yells “INFLATION!” and jacks interest rates… squashing increased wages.
And you wonder why average people ignore economics…
Not necessarily, “jjj”. The Asian surplus is not only from consumer widgets sold to Americans but from foreign investments and other sources. And there is no increase in savings… More important is the US GDP growth (saving rate x GDP). The oil money can find its way to the US directly or inderectly through Asia.
As long as the dollar is the reserve currency the US Treasuries will have demand even if the US economy is lousy. It is possible that this is what is at stake: if the hard landing comes, it will mean dollar losing its status as the only reserve currency. History knows situations when there has not been no sole reserve currency and we might be heading towards this.
The real problem with dollar as the reserve currency is the diminishing importance of the US in the world economy. The share of the US foreign trade and its manufacturing have decreased (US exports are about 9% of world exports, its industrial production share in the world just above 10% – the US is now behind China in both areas). And worse, the US share in the world economy is continously shrinking. The US domestic services doesn’t really count here.
When the dollar established itself as the world reserve currency the US share in global economy was clearly dominating. At best its industrial production was about one half of the world production.
The dollar has been able to keep its status mostly because there have not been any real competitors. The euro is not ready and Europe is a no-growth zone. The Chinese renminbi is not ripe at all. Japan is too small. Gold is too awkward. The US can still provide the necessary services and liquid markets. But this may not be enough.
I’m no expert in the matter of U.S. personal saving rates, but it seems to me that the way it is calculated is really screwed up. Retirement plans are not properly accounted for, and along with perceived home equity are likely an individuals greatest source of savings. Is this a reasonable statement?
I wonder why this is suddenly such a worry. According to a 2002 analysis by the SF Fed (citing BEA statistics), the PSR was roughly 9% in 1992, at which time it began a precipitous decline to 1% in 2000. This decline occurred during a period renowned for its prosperity and all-around excellence.
Is the methodology for computing the PSR flawed? Is the measurement of any of the components biasing the results? I am a pension actuary and I know the period of decline in the PSR coincided with a period where many companies were not required to make contributions to their defined benefit pension plans due to limits on deductible contributions. I do not know how much effect that could have had on the PSR.
….so what’s the benefit of more ‘savings’ to the average American ??
‘Saving’ Federal IOU’s {..dollars} with an official “inflation-rate” of ~3% … and a ‘real’ inflation-rate of 6-12% is a fool’s errand !
My bank is paying only 3% interest on my savings — and the Feds & State even want their April 15th cash tribute on that trivial amount.
Where da ya think Bush’s $200 Billion fer tidying-up Hurricane Katrina is coming from — the Federal “printing-presses” ….. so lots more inflation/dollar-devaluation coming.
“Savings” in U.S. Dollar-denominated vehicles is fer
chumps.
Do not save dollars! Heres why, It now takes $2.00 to buy what a nickel bought when I was a kid. When zebras lose all their stripes the politicians will become morally honest.Keep checking the zoo to see when it happens.
“Asian money flows are so huge that they override the rules of conventional ecnomics. These flows are not really generated by the US monetary policy but the US monetary policy has been made possible by them.”
TI sounds like Ben Bernanke claiming a global savings glut aka the rest of the world is abnormal, not us.
The only reason why Asia has so much money is because US consumers have been lapping up all their products. Need a LCD TV? Kching, thank you v. much says Sony. Need a Dell laptop? Kching, thank you v. much says Quanta, the Taiwanese manufacturer which builds them for Dell. Need a new cellphone? Kching, thank you v. much says FIH, HK based manufacturer which makes as much as 20% of the world’s handsets.
What made the fervent US consumerism possible? Some people say it was the Fed’s interest rate cuts…..
The Capital Fundamentalists Ride Again
In a recent post on the savings rate, James Hamilton of Econbrowser writes In the long run, a key determinant of national income is national wealth, which is only acquired over time through national saving. I have no beef with…