Household savings rates in the United States have recently crept up from all-time lows. Some have suggested that a shift toward frugality will hamper GDP growth-the Keynesian "paradox of thrift." We estimate that households compensate for a fall in their asset income by saving more out of their labor income, dollar-for-dollar. In the wake of the crisis, our model predicts that such primary savings will increase, but only temporarily and modestly, as household assets stabilize. As savings flows gradually accumulate, they help rebuild corporate net worth and hence firms' capacity to make capital investments. A timely return to pre-crisis levels of capital investment would require that U.S. households save substantially more than the model predicts, starting now. Hence, we should fret that our savings rates may be too low.
, through a Keynesian “paradoxofthrift” (POT) channel. By contrast, David Rosenberg and others have suggested that increased savings will be also be an essential part of the recovery, as households struggle to repair their balance sheets. Still others, like Time Magazine’s Nancy Gibbs (in a recent cover story), suggest that a “new frugality” may have taken hold in the United States. A change in attitudes, or market conditions, or both, may signal a lasting change in household savings behavior. Some commentators have forecasted that savings rates will soon reach levels
-insurance in industrial countries.
I always remind people to look at revealed preferences of individuals and companies. And what that tells you today is that the private sector feels it needs to self-insure more.
Everybody knows that, beyond a certain point, self-insurance can become very inefficient. Also, from a policy perspective, it results in all the paradoxes that we know about—the paradoxofthrift, the liquidity trap, neo-Ricardian equivalence, etc.
Bottom line, if this rather unusual phenomenon is not well understood, it is going to make the path dependency of
Frugality” Scenarios: Structural Shifts In The Model
VI. Pleasant Pigovian Accounting? Further Reflections on the ParadoxofThrift
A. An Accounting Model
B. Prospective Paths for Consumer Expenditures
C. Capital Investment
VII. Summary, Conclusions, and Directions for Future Work
Appendix A. Data Definitions
Appendix B. Assessing Transversality: Primary Savings and the Level of Assets
Appendix C. Estimation Details
1. Model Setup
2. Coefficient Estimates: Long-Run and Short-Run
Appendix D. Pleasant Pigovian
, especially in the crisis-hit economies, as well as in emerging economies such as the Middle East and North Africa region, where they have contributed to political instability.
5. Downside risks have increased and are severe. The overarching risk is of a global “paradoxofthrift” as households, firms, and governments around the world reduce demand, with many advanced economies unable to lower policy rates further. Immediate risks are centered in the major advanced economies, principally the euro area and the United States. But policy makers need to take
are already high, a widespread move toward current account surpluses at the worst possible time—an international “paradoxofthrift.” Moreover, in addition to contributing to the crisis by fueling excess demand for U.S. financial assets, reserve accumulation is an individually costly and collectively inefficient way to protect against crises stemming from a lack of confidence in multilateral insurance through international financial institutions, especially the IMF. Rather, there is a need to rebuild confidence in the system. The level of resources this requires and
The global economy has entered a dangerous phase. Policy makers must act boldly to finish the job they began in 2009, lest the gains from the recovery since then be lost. Collective action can put the global economy on a path to strong, sustainable, and balanced growth.
? There are several options. The first one is fiscal austerity: a government can cut spending, raise taxes, and thus increase public savings. But that option, if too front-loaded, leads to the Keynesian paradoxofthrift: if the fiscal adjustment is too fast, the economy may contract again, and the goal of reducing deficits and debt may fail. This is partly what has been happening in the euro area and the UK. The second option is a coercive debt restructuring/reduction. That option might become necessary and unavoidable if a country has an issue of solvency rather than
widen the output gap. Attempts to increase saving by cutting back on spending could even be self-defeating at an aggregate level if such cutbacks lead to near-equivalent reductions in income (“paradoxofthrift”).
In contrast, measures to (i) ease liquidity constraints by mobilizing illiquid assets and (ii) facilitate debt restructuring in ways that are mutually beneficial to both debtors and creditors could help reduce debt in ways that boost, rather than dampen, the recovery.
Easing liquidity constraints
12. Liquidity constraints can lead to sub
increase in the tax rate would reduce the after-tax real interest rate and increase lending—a paradoxofthrift. Figure 8 shows how an increase in inflation would increase the nominal interest rate less than proportionately. The lending function shifts up more than proportionately, but the borrowing function only proportionately, to an increase in inflation. Hence the nominal interest rate would increase less than proportionately, and the after-tax real interest rate would fall.
Figure 7. Increase in Tax Rare Under Modified Lending Equation ( di / d τ = −α 1 i /Δ