Tuesday, January 13, 2009

Kevin Drum's grasp of economics almost always astounds me

Today, however, I think he gets something plain wrong.

He writes

Tax cuts, similarly, are in ill repute because they don't necessarily increase consumption. People are more likely to sock the money away in a savings account or use it to pay down credit card debt. So there's no bang for the buck.

But surely this is short sighted? Stimulus spending can (we hope) help keep the economy afloat over the next couple of years, but then what? When the economy starts to recover, it will certainly be helped along if bank balance sheets are in better shape than they are today. Likewise, it will be helped along if consumers have paid down some of that credit card debt and put a few dollars aside. Right? We can't keep running a negative savings rate forever, after all.

I comment.

If money from a tax cut is saved, there is no effect on national savings. We just have more public debt and less private debt (if it is spent national savings falls).

We will collectively be just as much in debt as we would have been without the saved rebate checks. However, we will think were are less in debt (because people don't keep track of their share of the national debt).

That means that savings out of the tax cut will contribute to the national illusion that we are richer than we are. That illusion contributes to, indeed probably is the principal cause of, our low national savings rate.

People save now to spend later. We want people to spend now that we are in a recession and a liquidity trap. We don't want people to spend later when monetary policy can keep us at full employment. Saved rebate checks are bad for exactly the reason which makes you think they are good.

On the other hand, I agree with him on this one except that he puts it better than I did.


Anonymous said...

Nicely done and important.

reason said...

I disagree because the risk of default makes the relationship non-linear and you are treating it as linear. Read Steve Keen on debt deflation. Improving individuals balance sheets is a plus, the government isn't so likely to go belly up.