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Five macroeconomic myths?
Here is Ed Prescott's list. Here is the thumbnail version:
Myth No. 1: Monetary policy causes booms and busts
Myth No. 2: GDP growth was extraordinary in the 1990s
Myth No. 3: Americans don't save
Myth No. 4: The U.S. government debt is big
Myth No. 5: Government debt is a burden on our grandchildren
Where to start?
In my view #1 is 53 percent true, not a myth, #2 is a debate over semantics, #3 is indeed a myth though we should save a bit more, interpreted literally #4 is myth but let's not forget the real problem is forthcoming demographics combined with Medicare, and #5 is mostly a myth although the illusory "government debt is net wealth so let's spend more than we ought to, thereby reducing the capital stock" effect is not zero.
Posted by Tyler Cowen on December 11, 2006 at 03:03 PM in Economics | Permalink
Comments
Saying that the US government debt is not big, by ignoring the parts that are accumulating the giagantic debt..... is most unfortunate.
Kotlikoff says that with the coming retirement of the "baby boomers" we'd need a 109% increase in payroll taxes to right our fiscal affairs. Or some other bunch of remarkable adjustments.
http://www.typepad.com/t/comments
Is Professor K way off here?
Posted by: Dave Meleney at Dec 11, 2006 3:35:41 PM
Professor K is one of those who is all
hysterical about social security, which is
not a problem. The idea that it is "in
crisis" is much more of a myth than anything
mentioned by Prescott.
The problem with #5 and why it is less and
less a myth, even if social security is not
a problem (medicare and medicaid are, big
time), is that now a majority of our national
debt is owed to foreigners, with a rising
proportion of that being the case. This
is tied to the fact that #3 is also not a
myth. If it were, we would be financing
our own national debt and not bequeathing
a rising future burden of interest payments
abroad on our descendants.
Posted by: Barkley Rosser at Dec 11, 2006 4:49:08 PM
Whether foreigners or Americans own U.S. debt only has implications for the distribution of the burden (along with who pays taxes) not whether or not it is a burden.
The other problem with debt is that the burden depends a lot on what happens to long-term interest rates in the future. Add to this the fact that an increase in the debt has a small but still very real effect on long-term interest rates and debt becomes more of a problem. Right now, long-term interest rates on U.S. debt are extraordinarily low but few people expect this to last unless policies in the U.S. change.
Posted by: Mark at Dec 11, 2006 6:48:30 PM
A little ancient monetary history, just in case recent history has you doubting the connection between monetary policy and booms & busts:
“The retirement of a large proportion of the circulating medium through annual taxation, regularly produced a stringency from which the legislature sought relief through postponement of the retirements. If the bills were not called in according to the terms of the acts of issue, public faith in them would lessen; if called in there would be a disturbance of the currency. On these points there was a permanent disagreement between the governor and the representatives, discussions concerning which reveal themselves in 1715 and traces of which are frequently found after that date.” (Davis, 1910.)
Posted by: Mike Sproul at Dec 11, 2006 8:29:52 PM
Concerning #1 : Is your view of 53% truth representative of the relative weights you assign to the explanatory power of Austrian business cycle theory and RBC theory?
Posted by: echo at Dec 11, 2006 8:52:36 PM
"In my view #1 is 53 percent true, not a myth"
Prescott may agree with your view:
One caveat: I am not saying that there are no real costs to inflation -- there certainly are. And if we get too much inflation we can exact high costs on an economy (witness Argentina as an example). However, I am talking here of the vast majority of industrialized countries who live in a low-inflation regime... It is simply impossible to make a grave mistake when we're talking about movements of 25 basis points.
You could read that as "Really bad monetary policy causes booms and busts; the effects of mildly suboptimal monetary policy get lost in the noise." Which would make the original statement 32% truth (by weight, not volume), so you and Prescott are pretty close here.
Posted by: eddie at Dec 11, 2006 9:07:52 PM
The assertion that “Americans don’t save” is simply a fact. Check out the NIPA data over at www.bea.gov (Table 2.1 and Table 5.1). Back in 1992 personal savings were 5.78% of GDP. In 2006 they have approached -1% of GDP. A personal savings rate of roughly 6% back in 1992 may or may not have been adequate. Presumably -1% is not.
This trend has been noted many times in many places. Take a look at the following graphs www.flickr.com/photos/peter_schaeffer/174294887/in/set-797819/, www.flickr.com/photos/peter_schaeffer/174294357/in/set-797819/, and www.flickr.com/photos/peter_schaeffer/81669528/in/set-797819/.
The decline in personal savings probably has several origins. However, the wealth effect would appear to be dominant. As wealth has risen savings have declined. Indeed, MEW (Mortgage Equity Withdrawal) has become a major source of cash flow for current expenditures. See www.flickr.com/photos/peter_schaeffer/87645379/in/set-797819/ and http://www.flickr.com/photos/peter_schaeffer/36088669/in/set-797819/ for some MEW statistics. See www.flickr.com/photos/peter_schaeffer/36105563/in/set-797819/ and www.flickr.com/photos/peter_schaeffer/36105565/in/set-797819/ for some statistics on household net worth.
Current household wealth is dominated by housing. If anyone thinks current house prices can be sustained take a look at www.flickr.com/photos/peter_schaeffer/319801531/in/set-808572/. How many letters are there in “bubble”? The reality is that housing prices will revert to trend over time and the wealth effect will disappear. As it does, savings will rise and domestic expenditures will fall. Unless exports rise exactly in tandem, the adjustment process will be painful. Given the existence of Bretton Woods II (de facto fixed exchange rates), the opportunity for an easy expansion of exports to replace domestic demand is precluded. The outcome may not be pretty.
Overall, Americans are not saving enough. Personal savings have gone negative. The corporate sector does generate some net savings. However, government (state and federal) has net deficits. Overall, total savings are 1.7% of GDP of late (Q2 and Q3 of 2006). Throughout most of the post WWII period this number was around 10% of GDP.
Posted by: Peter Schaeffer at Dec 11, 2006 11:34:43 PM
I posted this to the old thread, but it's relevant here...
Actually, personal savings rates do NOT include 401K contributions or traditional IRA contributions (although Roth IRAs do count) because it's computed on disposable income, which is computed on taxable income. 401Ks and traditional IRAs are not part of taxable income. Also, the employer match on 401K is not counted as personal savings, although most people would think of it that way. And as mentioned, investment growth doesn't count either, but passive income that's saved does count...
I realized that my wife and I had a negative savings rate by the national calculations last year because we had maximally funded our 401Ks and paid cash for a car. But if 401K contributions were counted, we saved over 20% of our gross, even if the car is counted as pure consumption (which we do...)
Posted by: Foobarista at Dec 12, 2006 4:14:00 AM
Also, I wonder if the decline in personal savings rates tracks the raise in the maximums for 401K and IRA contributions over the past few years - since money that used to be saved in post-tax accounts - and counted in the personal savings rate - can now fund a 401K or IRA. I've frankly found the "sudden discovery of profligacy" narrative rather tiresome, since consumer capitalism wasn't exactly discovered yesterday. I suppose new home loan vehicles are be pumping some people into higher levels of spending stupidity, but my suspicion is that this is overrated.
Posted by: Foobarista at Dec 12, 2006 4:18:36 AM
"personal savings rates do NOT include 401K contributions or traditional IRA contributions (although Roth IRAs do count) because it's computed on disposable income, which is computed on taxable income."
I'm not positive, but I think personal savings is the difference between after-tax income and household expenditures. I don't think taxable income is the same thing as Commerce Department's definition of after-tax income.
What personal savings does not include is any nonrealized or capital gains. As I understand it, it also doesn't include the value of pension assets.
Posted by: JohnDewey at Dec 12, 2006 7:43:31 AM
Foobarista,
I was mistaken about one point. Apparently the Department of Commerce does include in disposable income an employer's contributions to pensions funds, to insurance funds, and to government social insurance (social security). I can't tell from the definition whether or not that includes employer contribution to 401K plans.
I do not see in the definition any reduction for employee contributions to 401K or other tax-deferred savings plans.
Here's the link:
http://tinyurl.com/wlcad
Posted by: JohnDewey at Dec 12, 2006 9:50:15 AM
Why the fascination with savings as defined by "wages and dividends minus expenses"? Why disregard increases in net wealth due to asset appreciation? Okay, sure, asset values can fall. But people can lose jobs, too.
To suggest that people's expenditures should be equal to the same percentage of their income regardless of how quickly or slowly their wealth is growing is absurd. Suppose a pirate ship passed by your house once every year. Some years the pirates throw treasure overboard, some years they steal your car. Would you be wrong to increase your spending during the treasure years and cut back on spending when you lost your car?
Posted by: eddie at Dec 12, 2006 9:50:54 AM
eddie: "Why the fascination with savings as defined by "wages and dividends minus expenses"? "
Well, it is a number for which we have historical data.
From the end of the depression, 1950, through 1992, the U.S. personal savings rate remained above 7 percent and averaged about 9%. It was even higher during the World War II years, presumably because Americans bought war bonds.
Since 1992, the personal savings rate has steadily declined until it was negative in 2005. This is not a seesaw pattern, where savings are up one year and down another. Additions to personal savings remain down sharply, and this is unprecendented in the post-Great depression era.
What's troubling to me is that 1992-2005 should have been wealth accumulation years for Boomers. That's especially true if they believed that either Social Security or Medicare may not be fully funded during their retirement. If you've talked to many Boomers - I am one and I have talked to others - you'd know that most have been saying they're not counting on Social Security and Medicare. But they're also not saving at the same rate as their parents were. Some are saving more, but overall they just aren't showing the same behavior that preceding generations have.
I foresee problems in 20 years when many Boomers won't have the savings to meet the high costs of medical insurance. Boomers may expect their grandchildren to pay for - through Medicare taxes - almost all of their health expenses. That's just wrong.
Posted by: JohnDewey at Dec 12, 2006 10:49:54 AM
According to several sources, including the BEA, personal savings do include 401K contributions. See http://bea.gov/bea/ARTICLES/2002/04April/0402PersonalSaving.pdf for a detailed discussion of this subject (along with other related topics). A useful quote
“Treating pension funds as part of the personal sector in the NIPA’s causes the net saving by pension plans to be included in personal saving. This treatment seems appropriate for defined contribution (DC) pension plans, such as 401(k) accounts, which are in many ways similar to individual retirement accounts (IRAs).”
Another source, http://plansponsorinstitute.blogspot.com/2006_04_01_plansponsorinstitute_archive.html, makes the same point
“As it is currently defined, NIPA’s definition of personal saving is simply the difference between personal disposable income and personal spending. Personal income includes wages, asset income (dividends and interest), rental income, and supplements to wages, including those pension and 401(k) contributions. And yes, it counts those pension contributions made by employers to traditional defined benefit plans as though they were individual income – but not the subsequent gains (or losses) they might incur.”
In my prior post, I provided citations for the magnitude of MEW (Mortgage Equity Withdrawal). Unfortunately, estimates of MEW are all over the map. Calculated Risk (a blogger) came up with $540 billion for 2005 and $156 billion for the first half of 2006. The New York Times came up with much bigger numbers (which CR disputed). As for the significance of MEW, take a look at http://bigpicture.typepad.com/comments/2005/12/chart_of_the_we.html. According to the author the US would have had close to zero GDP growth since 2001 without MEW. See also http://calculatedrisk.blogspot.com/2006/12/mortgage-equity-withdrawal-declines-in.html by CR.
For the record, 401K contributions aren’t as large (relative to GDP) as some people seem to think. According to http://www.nber.org/aginghealth/fall02/changingCharacter.html they were $176 billion back in 1999. Presumably they are higher now.
Aside from statistical questions (are 401Ks included?), the entire debate about whether Americans are saving enough comes down to changes (increases of late) in wealth. The “no savings problem” crowd (mostly on the political right) is eager to include capital gains as “savings”. While sustained capital gains can eventually be used to pay for current consumption (in retirement), they are not “savings”. Savings are defined as deferred consumption either in the personal sector, corporate sector, or by government.
The problems associated with treating capital gains as savings are not just matters of language. The real issues are whether they (the gains) can be maintained long enough to support the retirement of millions of Americans. Above I posted the link to Shiller’s graph of home prices. Can anyone doubt that mean reversion will occur at some point in the future? Stock prices face similar problems. Tobin and Smithers have asserted that market values can not exceed replacement costs over the long term. This means that future equity gains are far from assured.
Posted by: Peter Schaeffer at Dec 12, 2006 12:26:54 PM
Peter, thanks for clearing up teh definitions.
I am surprised the 401K total is that small. As most plans contain some amount of employer match, it's hard to believe employees can just forego compensation. But I know that many do. I wonder how much it would raise median income if employees would stop being stupid.
Posted by: JohnDewey at Dec 12, 2006 12:47:00 PM
How much of this is attributable to demographic changes? When people retire, I expect their spending to remain relatively constant, but their income to drop. Thus, their savings rate drops. When people are in school, I also expect them to have a negative savings rate. If we simultaneously have more people lengthening their stay in school and retiring, as a percentage of the population, wouldn't you expect to see the savings nationally drop?
I don't know if either of these demographic trends are occurring, but I suspect they are.
Posted by: Steve at Dec 12, 2006 12:55:51 PM
steve: "When people retire, I expect their spending to remain relatively constant, but their income to drop."
I think that's true. The leading edge of the baby boomers is just entering retirement age. Those born in 1946 are now 60. We can expect those boomers to stop funding 401K's, stop accumulating pension assets, and stop paying FICA taxes, all of which would be considered savings.
The personal savings rate has been steadily declining since 1992. Boomers have been in their peak earnings years the past 14 years. They should have been saving more after the kids left home and as the Boomers neared retirement. The savings rate should have risen since 1992, not dropped.
Posted by: JohnDewey at Dec 12, 2006 2:11:01 PM
Check out Greg Mankiw's blog and his critique of myth #5 (the link is on the side of the page).
Posted by: ZH at Dec 12, 2006 6:17:31 PM
Peter:
The problems associated with treating capital gains as savings are not just matters of language. The real issues are whether they (the gains) can be maintained long enough to support the retirement of millions of Americans.
Isn't there a reciprocal question of whether real incomes can be maintained?
I'm having a hard time distinguishing between getting a $10,000 Christmas bonus and seeing a $10,000 rise in my stock portfolio (tax implications aside). In either case, I'm going to spend the same amount, and whatever's left over is going into my portfolio. Why should we be more worried about the second case than the first case? The end result is the same: in both cases everyone's net worth has the same value and is held in the same manner, and everyone has the same consumption. Only the "savings rate" is different. Why is this not merely a matter of language? Where is the economic difference?
If you think that there is a difference, I'd be happy to trade you the most recent $10,000 your stock portfolio went up in exchange for a contract job paying $9,000 for writing a blog post explaining the difference.
Posted by: eddie at Dec 12, 2006 9:00:37 PM
Eddie,
The $10K bonus is yours to keep forever. The $10K gain in your portfolio can and will mean revert. Do you know any folks who were temporary millionaires back in 1999/2000? Who have very little or nothing left now? Stock values are limited by Tobin’s Q (see also Smithers work on the same subject). This means that equity values can’t sustainably exceed book value minus debt.
Of course, you can sell your stocks and capture the $10K in cash. However, the buyer will ultimately suffer mean reversion. Between the two of you, no net gain will occur.
Unless you have found a way to make sure that equities and houses (along with other asset classes) never mean revert, capital gains are the temporary illusion of wealth, not the reality. Real savings requires deferring consumption and using the forgone consumption to create assets. Transitory capital gains don’t suffice.
Posted by: Peter Schaeffer at Dec 12, 2006 9:47:49 PM
The $10K bonus is yours to keep forever.
Unless I put it in the stock market, at which point it will eventually disappear when the market reverts to the mean.
The $10K gain in your portfolio can and will mean revert.
Unless I cash it out and put it in my mattress (or bonds or gold or some other asset I might guess is underpriced rather than overpriced).
What happens to my money after I get it depends on what form I keep it in and is independent of how I got it in the first place. The only difference how I got it makes is to the savings rate. What am I missing here?
Real savings requires deferring consumption and using the forgone consumption to create assets. Transitory capital gains don’t suffice. [Emphasis added]
I think the key term here is "transitory". Considering that word, I'd agree with you. But I think the world of difference lies within that word. I don't dispute that capital gains can be transitory; you seem to be taking the position that capital gains are of necessity transitory.
If assets were always correctly priced, so that a dollar of capital gain reflected a dollar's worth of actual increase in the value of the underlying asset (say, for example, an apple tree that had grown slightly larger and now produced slightly more pies per year) - wouldn't such capital gains be as good as deferred income? And if so, then pray tell, how are we to determine the correct prices of assets? Is everyone dumping their 401K money into index funds just a bunch of suckers who obviously don't understand the implications of Tobin's Q?
Posted by: eddie at Dec 12, 2006 10:32:00 PM
You need to include all the real estate investment since 2000.
I'm in a non bubble area with little reason to believe my investments will decrease in value. In the past five years I have bought and rehabbed two homes that I now use for rentals. On paper I have spent 250k, but reality is that I am now ahead about 70k. There has been A LOT of this type of activity in the past five years. Some of this spending is also adding value to people's personal homes. It may be less liquid than a bank account but it is real.
With the ease of obtaining a line of equity people can now divert their emergency savings into more profitable investments.
Our wealth continues to grow.
The 'declining' savings rate is a product of our illiquid past and poor definition of savings.
Posted by: Tom at Dec 13, 2006 9:38:08 AM
Wealth and/or assets are very different things then savings.
Wealth can change for many reasons. But it still comes down to ownership of an asset.
You can borrow against wealth to finance consumption or investments, but you can not directly use it to finance consumption or investment. If you borrow against it it means someone else has given up the use of the resource you are now using so there is
no net change. That is the big difference between wealth and savings. Savings is foregoing current consumption and diverting resources to other purposes.
But wealth is not that.
the dominant reason we have a current account deficit is to cover the drop in personal savings over the last quarter century. If savings had not fallen we would not need the foreign savings.
The attempt to make savings and wealth sysnonymous by people like Prescott is one of the most misleading uses of economics ever. It is an act of deliberately dishonesty to advance an ideological point of view and to hide the failure of the economic policies they have advocated for a quarter century.
Thank you Peter Schaeffer for your corrections on the 401K meme.
Posted by: spencer at Dec 13, 2006 9:57:21 AM
spencer:
"Wealth and/or assets are very different things then savings." True. Wealth is a stock. Savings is a flow. Capital appreciation is also a flow.
"You can borrow against wealth to finance consumption or investments, but you can not directly use it to finance consumption or investment." So, I can't take money out of my Schwab account and spend it? Or for that matter use it for investment? Funny, I thought investing it was the reason I had it in my Schwab account in the first place.
"Savings is foregoing current consumption and diverting resources to other purposes." Purposes such as... adding to your net wealth! What other purpose besides current consumption is there?
Savings adds to net wealth. Capital appreciation (as long as it isn't "transitory") adds to your net wealth. Wealth is used to finance future expenditures. Both savings and capital appreciation work just fine for financing future expenditures. Did money become non-fungible recently and I just didn't get the memo?
If Hans Gruber had taken his bearer bonds and earned twenty percent in interest while sitting on a beach his $64M/year (I'm assuming his split was 50%; it was his plan) would be called income. Assuming his needs were a modest $6M/year he'd have a 90% savings rate. But if he invested it in Microsoft (making him about a 10% stakeholder in 1988) and periodically sold off some shares to finance his modest needs he would have a negative savings rate. Infinitely negative, in fact: $0 income - $6M spending / $0 income. Does it really make a difference to the economy whether Hans is financing his retirement by loaning money to a company versus investing in a company?
Posted by: eddie at Dec 13, 2006 11:02:35 AM
eddie --- the only way you can take your money out of your Schwab account and spend it is to find another individual to buy it from you. That is what Schwab does, acts as a middleman and it earns its keep by charging a fee to you for finding a buyer.
That is why in the discussion above brokerage fees are included in the calculation of gdp.
Individuals can do what you say, but the whole population can not do it.
Posted by: spencer at Dec 13, 2006 1:34:58 PM
