Given the politics of the moment, the compromise deal on extending the Bush tax cuts was an all-or-nothing proposition. Either Republicans and Democrats would get everything they wanted (of the things that mattered), or everyone would leave empty-handed.
Obviously we ended up with the former.
Keep that in mind as you look at these next two graphs, the first from the Cleveland Fed:
And second, here’s the evolution of the personal savings rate over the last ten years, courtesy of Fred:
As you can see, the savings rate appears to be stabilising at about 6 per cent — much higher than where it’s been for most of the past decade, and approaching something that looks like normal for the past twenty years (though not for the twenty years before that).
This has led to a gradual decline in household leverage, though as you can also see, it seems to have a way to go.
But in his well-reasoned and guardedly optimistic essay from a couple of weeks ago, Greg Ip made the point that household deleveraging was far enough along that it could continue even while consumers started spending again:
Over time, the headwinds of consumers paying down debt will fade. The process is about halfway done. Personal saving had already risen to 6% of income by the summer of 2010, from under 2% in 2005. Some optimistically reckon that’s as high as it needs to go. Meanwhile, household debt peaked at 135% of disposable income in late 2007; by the middle of 2010 it had fallen to 123%. Economists at Deutsche Bank project that, if the saving rate stays at 6%, banks continue to write off bad loans at their current rate and income grows by about 4.5% a year, that ratio will be down to 107% by the end of 2011.
That process — of households simultaneously saving and spending more — may have already begun, if slowly. And with other signs that the economy is perking up a bit, Ip’s assumptions are easily within the realm of possibility.
Unless, of course, something derails this activity and sends the savings rate even higher — something like tax increases or an end to unemployment insurance. (There are other possibilities too, of course, such as another blow to unemployment or the continuing erosion of home prices — both of which are unfortunately quite plausible.)
None of the provisions in the compromise is uncontroversial in how effectively stimulative it would be. We can safely predict, for instance, that the tax cuts for high-income households won’t do much at all. But even sounder ideas such as the payroll tax reduction aren’t without their skeptics.
All the same, if the fragile recovery is to either gain momentum or at least stay moving in the right direction, it’s also important not to give individuals and households any additional disincentives.
This compromise is unlikely to accelerate the recovery the way a better-designed stimulus package might have, but to have done nothing and slowed it down would’ve been good deal worse.
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Here’s a couple of other related items we picked up while scanning around the web just now.
First, Free Exchange posts a cost estimate of the deal from JP Morgan analysts:
For fiscal year 2011, we are now looking for a fiscal deficit of $1.5 trillion, up from $1.2 trillion. This is very preliminary, but the revision incorporates about a $120 billion reduction in payroll withholding taxes, about $50 billion in more jobless benefits, over $100 billion from depreciation allowances and $10 to $30 billion from the other expiring tax credits. For fiscal year 2012, we have revised up our deficit forecast from $1.1 trillion to $1.2 trillion.
Second, Economix links to analysis from the Center for American Progress estimating that the deal will “save or create 2.2 million jobs, excluding jobs associated with the extension of the broader-based portions of the Bush tax cuts on which all parties were agreed”.
These kinds of analyses invariably require a lot of assumptions. But even if this one is right, we suspect most of those jobs will be in the “saved” rather than the “created” category.
Related links:
Taxes in Wonderland – FT Alphaville
More on those “record” profits – FT Alphaville
The return of (very cautious) optimism – FT Alphaville