THE STASH JULY 15, 2009
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Paul Krugman highlights an incredibly important point from yesterday's daily report by Goldman economist Jan Hatzius:
The private sector financial balance—defined as the difference between private saving and private investment, or equivalently between private income and private spending—has risen from -3.6% of GDP in the 2006Q3 to +5.6% in 2009Q1. This 8.2% of GDP adjustment is already by far the biggest in postwar history and is in fact bigger than the increase seen in the early 1930s.
Which is to say, we've swung from spending to saving even more sharply than we did during the Depression. Had we done nothing, the macroeconomic effects would have been similar. As Krugman puts it, "government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression."
It's also worth pointing out that government is at best only partially offsetting the private-sector adjustments going on here. As Hatzius writes further down:
Consistent with the private spending retrenchment, debt among households and nonfinancial businesses is actually declining for the first time on record (the data go back to 1952). Debt growth has fallen from +10.6% (annualized) in 2006Q1 to -0.7% in 2009Q1. Moreover, total nonfinancial debt growth has also slowed from a peak of 9.9% (annualized) in 2005Q4 to 4.3% in 2009Q1, as the increase in Treasury borrowing has only partially offset the collapse in the private sector. Finally, total debt—nonfinancial and financial—is shrinking rapidly, even if we include the federal government.
Again, depressions are what you get when you don't ease these adjustments, even if you think they're ultimately necessary. (And clearly our level of borrowing was unsustainable.) We've done some of that, but it seems to me (and Hatzius--and Krugman) that we could do a lot more.
P.S. John Judis made some of these same points in a great piece last week.
--Noam Scheiber
13 comments
Noam, I think it's "Undertow."
- ironyroad
July 15, 2009 at 2:36pm
Irony, I don't get it, what was written before? Please say "undertoad"
- blackton
July 15, 2009 at 5:35pm
"Undertoe"
- ironyroad
July 15, 2009 at 7:23pm
Yeah, if ever there was a proper usage of the "undertoad," this is it.
I am not so sure about this. If there is excess private savings, then there has to be a corresponding government deficit. So, the automatic stabilizers that did not exist in the '30s would be producing a higher budget deficit that must then appear as excess private savings. In other words, I think that Krugman may have cause and effect reversed here. It seems to me that the automatic stabilizers that mitigate the recession would produce just the effect seen. It therefore makes no sense to say that the leakage of savings is worse than in the '30s, at least not until you subtract the effects of the stabilizers. And then you cannot really say that the relatively sharper savings increase is only not producing a depression because of the stabilizers.
This may seem confusing, but I think Krugman is mistaken, or at least not interpreting this correctly. Boy, I never in my wildest dreams thought I would ever get to say that. Please someone, correct me, before I do it again! I feel wild and out of control.
- roidubouloi
July 15, 2009 at 7:48pm
thanks Irony, that is pretty funny too.
- blackton
July 15, 2009 at 8:00pm
The biggest realization was this:
“In equilibrium the private surplus equals the government deficit (not strictly true for any one country if you add in international capital flows, but think of this as a picture for the world economy).”
Which is what I've been saying for a while. Deficits are required to fund savings.
Roid,
I'm not sure about Krugman, but the problem at the outset of the 30s was that the lines in Krugmans graph cannot maintain that slope forever, since the sum of capital is fixed by the amount of gold. That's not the case now, we can maintain the slope indefinitely.
- acria multa
July 16, 2009 at 11:39am
Acria,
I'll have to check out that graph.
However, you are still mistaken about net savings. Note that what it says above is that the deficit equals the EXCESS of private savings over private investment. This is correct, if you include both domestic investment and foreign investment which equals net exports. It is perfectly possible to have savings in the absence of government and government debt, But any budget deficit must be financed with the excess of private savings over investment. Alternatively, there cannot be a budget deficit without an excess of private savings over investment. The budget deficit can be financed with net imports, but these can also be considered as negative private investment. Thus, if domestic savings and domestic investment were equal, total private investment would be reduced by net imports with the result that private savings would exceed private net investment by exactly the budget deficit.
Bottom line: The budget deficit equals private savings in excess of private net investment. It is not the case that the budget deficit equals private savings as you have stated a number of times.
- roidubouloi
July 16, 2009 at 9:59pm
What would be classified as private investment. And whatever is invested with someone, isn't that money then the recipient's private savings?
If it's possible to have savings in the absence of government, what is that savings denominated in? And who issued it?
- acria multa
July 16, 2009 at 10:32pm
Wait, maybe I realized the answer to my first question... you call private investment what I call aggregate demand? Aggregate demand being the total demand for goods and services.
- acria multa
July 16, 2009 at 10:34pm
Acria,
I have twice written a post on this that has disappeared.
The short response is that investment is not aggregate demand. Investment is the acquisition of those things that are used from production of consumption goods and services: plant, equipment, organization, education, infrastructure. The Federal deficit equals the excess of private savings over private investment. This may seem counter-intuitive because the savings decision and the budget deficit don't seem to be directly related. However, the adjustment variable is output or GDP. If consumers try to save more than is being invested in the absence of a budget deficit, the result is to reduce demand and output by just that amount so that the excess savings disappear and output is reduced. This is the so-called "paradox of thrift." The only real savings, not offset by borrowing somewhere else in the economy, is either investment or acquisition of foreign claims because the liability side is outside our economy.
It is for this reason that government tries to offset reduced spending -- savings -- with budget deficits.
- roidubouloi
July 17, 2009 at 10:33pm
I've experienced the vanishing post phenomena as well, thanks for persevering :)
But the acquisition of those investments you describe would not eliminate the dollars used to acquire them, they only transfer ownership. That why I'm adding it in as savings. However, savings in my definition is just dollars. Not the investments or foreign claims.
For the rest, well I think I see now, we're in a chicken versus egg debate.
- acria multa
July 18, 2009 at 2:45am
You have to keep track of the real economy and the financial economy separately-- they circulate in opposite directions and you cannot mix them up willy-nilly any more than you can the assets and liabilities of a balance sheet. The real economy is the trade and production of real assets, goods for consumption and for investment/production. The financial economy is the trade and production of liabilities. Real things either exist or they don't and they take time and effort to create. Liabilities can be made to appear and disappear at will -- they are purely contractual and hence virtual. In the real economy, savings can only be investment because there is no other physical thing you can save except for relatively trivial amounts of consumption goods that can be stored for future use.
- roidubouloi
July 20, 2009 at 1:09am
Acria:
You yourself take note that "savings" only transfers ownership of liabilities. New liabilities implies new assets, hence investment, unless the liabilities are government liabilities. In that case, they are only transfers from those who do not add to their stock of government liabilities to those who do -- hence zero net savings.
- roidubouloi
July 20, 2009 at 10:28pm