A $200 dress? Or a relatively minor bump for your 401(k)? A years worth of Starbucks? Or £1,000 in your savings account? That is the question…
There’s a bit of a debate brewing about the structure of Obama’s planned $825bn stimulus.
Nobel-prize winning and ex-World Bank economist Joseph Stiglitz argues in today’s FT for instance that he is not a fan of the plan’s proposed tax cuts:
What is clear is that tax cuts will not help much. When Barack Obama, president-elect, last week proposed to use nearly 40 per cent of the stimulus for tax cuts, he was rightly told this would be less effective than, say, spending on infrastructure. It has been surprising, then, to see President George W. Bush’s former economic advisers, including Greg Mankiw, argue that tax cuts are the way forward.
Mr Mankiw cites a recent study by Christina Romer and David Romer, economists at the University of California, Berkeley, who found that each dollar of tax cuts raises GDP by about $3 (€2.30). Such studies, based on past data, may have little to say about the situation the world now faces. Americans confronted with debt, shrinking retirement accounts, houses worth less than mortgages and a tough credit environment will save more of their money than in the past…
This, however, seems intuitively uncomfortable. If much of the current credit crisis was caused by over-leveraged consumers, then is spending really the right way out of it? You can see from the below chart, that the US savings rate was hovering around zero in recent years — even managing to go negative after Hurricane Katrina wreaked havoc in 2005.
Bank of America analyst Matthew Moore has some startling commentary on the world and US savings situation:
Arithmetically, total savings of the world is zero. The way the arithmetic in the US worked during the expansion this decade was that large savings flows from abroad and business savings (amid strong profits) financed government borrowing and reduced saving in the household sector…
By his calculation, Americans saved about 80 per cent of the last stimulus cheque ($100bn given in February 2008). In the current plan:
The personal tax cuts in the stimulus plan are said to be $140bn. If, for example, households save 80% of that, then the stimulus plan would add $112bn to personal savings and drive the savings rate up to 4%. Since the tax cuts are permanent, less may be saved but any resultant increase in the savings rate would also be permanent.
And, as hinted above, that’s not necessarily a bad thing.
Further increases in the savings rate are also likely as retirement needs grow with continued advances in life expectancy. Savings rates may also increase due to lowered expectations of returns due to the financial crisis, necessitating a higher level of current saving to achieve a given level of future wealth and income. This rebound in savings is likely to reduce US dependence on foreign savings, which is important given that promised Social Security benefits will increase government borrowing as the Baby Boomers retire and the foreign sector may become less enamored with increasing their holdings of US debt.
Of course, complicating matters may be a growing public perception that the government is rewarding consumers at the expense of savers. Not to mention quantitative easing, which is gradually starting to seep into the public consciousness, albeit mostly in the form of “government prints money.” In the UK, you can argue, that the government has clearly signalled that tax breaks now will come at the expense of tax increases later — so why spend?
In any case, the trade-off between spending (a boost to the economy in the short-term) and saving (a repair of the balance sheet in the long-term) is an interesting one.
Stiglitz is clearly leaning towards a short-term economic boost — but he’s not unaware of America’s structural problems. From the transcript of his FT.com Video interview:
In the long run, we will have to address the problem of debt. In the short run, we have to get our economy going. If we don’t, the deficit will rise because tax revenues are going to fall. We are, to use that expression, between a rock and a hard place. We don’t spend the money, we have a big deficit. If we do spend the money, we have a big deficit. But if we do spend the money and it works and we spend it well, at least then there will be jobs and people will not face the hardship that they will face if we don’t spend the money.
…
…it will be many months before we see the light at the end of the tunnel. Almost surely at the end of 2009 GDP will be lower than it is now. Unemployment will be higher than it is now. So things may have turned around, but they will not have recovered. What worries me and what worries an increasing number of economists is, what happens in 2011? Do we emerge into a Japanese style malaise, or do we have a robust recovery? There’s every reason to believe that unless we don’t address some of the more fundamental problems facing the global economy and the American economy, it will be a Japanese style malaise. Because remember, what has sustained the American economy for the last five years? It’s been a consumption bubble sustained by a housing bubble. What we’re talking now is solving the problem of the credit crunch, but even after we solve that, we have the question, what will replace the housing bubble? Maybe another bubble, like we have the tech bubble, but that’s not a good answer.
Related links:
Obama’s multipliers – FT
Stiglitz: Do not squander America’s stimulus on tax cuts - FT
What’s your Obama tax cut? – AlchemyToday