Message to government: Get out there and spend now
The classic Keynesian position in times of economic downturn is that the public sector should step in with fiscal stimulus to compensate for falling demand by the private sector.
In effect, government becomes the public consumer substituting for the struggling or retrenching private consumer to maintain aggregate demand in the economy.
This is a bit of sleight of hand, of course, because the private consumer will still end up funding public consumption through future taxes and other imposts.
What the private consumer – wearing the voter’s hat – thinks of substitute public consumption undertaken on his behalf tends to be made known at the next general election.
Across the world governments are rolling out lavish emergency fiscal stimulus packages as they attempt to bolster faltering aggregate demand in the face of the global credit crisis.
The need for governments to take this course of action becomes apparent when the latest monthly “National Economic Trends” statistics published by the St Louis District of the US Federal Reserve are studied.
The lead article in the April edition – “Household Retrenchment” by Riccardo DiCecio and Charles Gascon – gives an insight into the mind of America’s private consumer.
The dominant thought presently weighing on this mind is implementation in practice of Keynes’s paradox of thrift, although probably not recognised under that name.
The paradox asserts that while it can be rational for individuals and households to cut consumption, slash debt, and boost savings in hard economic times, this response is irrational for the economy taken as a whole because it further reduces falling aggregate demand, postponing economic recovery.
According to Messrs DiCecio and Gascon, there is evidence aplenty that the paradox is hamstringing the US economy.
First, however, a glance at the preconditions they have identified for this crisis. Between 1959 and 1990 the average personal saving rate for the US private consumer was 9%.
Then things went haywire, with the average personal saving rate falling into negative territory by third quarter 2005.
Accompanying the savings crash was a household borrowing bubble.
Between 1990 and 2006 US household borrowing ballooned 400%, peaking out at an aggregate $US1.4 trillion by second quarter 2006.
Everything was set up to go at that point for the paradox of thrift to kick in.
Thereafter, US households launched a radical deleveraging campaign, with aggregate debt falling to negative $US279 billion by third quarter 2008.
A massive saving programme has accompanied the deleveraging, with the US average personal saving rate hitting 5% of personal disposable income by January 2009.
That is a huge turnaround in just over two years with ramifications extending far beyond the borders of the US, and possibly history’s largest example of the paradox of thrift in operation.
The saving / deleveraging was largely achieved by paying down mortgage debt as fast as possible, or simply defaulting outright.
The turnaround in household saving and leverage was associated with a collapse of residential property and equity market values.
The tipping point occurred over mid-to-late 2006, when residential property prices went into steep decline.
According to the National Association of Realtors, the US median one-family home price fell 25% between the 2006 peak and January 2009.
The US stockmarket – as measured by the S&P 500 index – followed suit by diving 50% between its October 2007 peak and February 2009.
The stockmarket is highly relevant to US household wealth because of personal retirement savings accounts held such as 401(K)s.
Messrs DiCecio and Gascon note additionally that tightening in the US credit markets has given further impetus to increasing savings and reducing debt.
The shock statistic published by Messrs DiCecio and Gascon is that, “Overall, between the third quarter of 2006 and the last quarter of 2008, Americans’ net worth shrank by 20%.”
That Americans are on average poorer by one dollar in five indicates the magnitude of paradox of thrift effects on aggregate demand in the US.
There are knock-on effects also being felt abroad in countries dependent on US imports and capital flows.
The need for emergency US fiscal stimulus, with Uncle Sam becoming the face of enlarged public consumption in place of anonymous private households, becomes only too apparent.
There must be similar processes under way in other credit-crunched countries such as New Zealand.
It would be an interesting study to compare household saving, deleveraging, and wealth decline rates across countries to gain some idea of how much and how widely demand substitution by fiscal stimulus is needed.
Right now the theme must surely be that government, as the public consumer, needs to raid the piggy bank to spend its savings, leverage its household equity to the hilt, and splurge out to the max on the credit card to keep the economy going.
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