Monday, March 19, 2012

Over Savings ?

Felix Salmon argues that the growth of US potential output has slowed. Time Duy notes that it is a demand side argument. I note that this isn't a contradiction in terms.

Robert Waldmann said...
I feel like defending Salmon. The idea that "potential" means "supply side" is not tautological. It is a hypothesis. There used to be a lot of economists who were convinced that demand couldn't grow without bound, so growth was permanently limited by demand (Keynes was not one of them). They sure have a lot of egg on their late faces. But they may have been off by only about a century.

The Salmon hypothesis is that people will never find a way to spend the huge incomes that the US top 1% make. So the only way demand can keep growing is for them to loan money to the bottom 99%. But this can't go on forever as default becomes too attractive (or unavoidable). Clearly we can consume more, but not infinitely more and a lot more than now only if income is redistributed.

The fact that this has not been true in the past, doesn't mean it isn't true now. The case against is accidental theory -- extrapolating the trend of consumption (philosophically like extrapolating the trend of house prices or .com valuations). Yes we can write down a utility function so consumption grows at the same rate forever (I did last Friday). We can write down utility functions with any implication we want. But that doesn't mean that the real world works that way.

Personally, I have unbounded faith in the unbounded gluttony of the US consumer, but I have no proof.

1 comment:

  1. That's my hypothesis as well.

    You have faith in the "US consumer," but as you note we can no longer be so broad -- middle class consumers have been providing that unbounded gluttony, and now they can't, and further demand growth has to come from a completely different set of consumers.

    So in your view, what has changed from the perspective of the 1% that makes them want to spend way way more than they have in the past? What about lower growth makes them want to buy all sorts of things they could have had anyway? Who spends more when their incomes drop? And will they not only spend their interest payments but do so within months of receiving it like the consumers they're replacing? Remember, it's the flow of money that matters, not the stock.

    The differences between the consumers who've been driving increased demand and the consumers you're predicting will take over that role are enormous. It just seems absurd to me to expect they'll not only pick up spending but replace the missing spending 1:1. Besides, they'll demand different things, and our productive capacity for what they would demand if their demand shoots way up is not going to be as good as our productive capacity for what the middle class has been demanding.

    Unless we replace the credit the middle class was getting with higher incomes, at the expense of the profits and interest that Wall Street was using to create that credit, we're in a very different economy demand-wise going forward.