Tuesday, May 12, 2009

Paradox of Thrift: Update



This graph from the BEA shows the US personal savings rate since Q1 of 2000. From it you can clearly see both the sharp decline in savings rates in the US in the 2005-2008 period and the sudden and strong retrenchment. This is what we speak of when we speak of the Paradox of Thrift. But what does this look like from an historical perspective? Here is the savings rate since 1947 (but before this recent uptick).



During most of the second half of the 20th century we were saving 8 to 10 percent of our disposable income. We are still pretty far from that, but it is the recent sudden reversal that has helped fuel this recessionary cycle.

2 comments:

Gregory said...

I haven't attempted to review the academic literature on thrift and savings. But I suspect higher savings rates, by increasing the pool of resources available to individuals, increases the stability of an economy and makes it less susceptible to shocks. In the past consumers had credit markets (credit cards, HELOCs) that could absorb much of the shocks, for example of job loss or emergency medical expenses. These mechanisms are now greatly reduced, which means more people might fall off the margins and into destitution (or back to their parents). The long-term effects of this could be catastrophic, or at least annoying to the parents.

The paradox is that Americans are increasing savings during a recession. Shouldn't rational consumers do the opposite: Increasing savings during an expansion (when resource costs are higher) and spending during the contraction (when resource costs are lower)? Even if individual consumers don't behave in this rational way, shouldn't governments have such a policy? Instead many states have balanced budget requirements that force them to cut spending during a recession, exacerbating the recession even further. Doesn't Oregon have some kind of rainy day fund?

Patrick Emerson said...

Gregory,

Yep, yep and yep. High savings rates mean that households can spend counter-cyclically which would help temper the recession. Instead US households went on spending binges and are now retrenching which hurts the economy in the short-run.

Oregon does't have a permanent rainy day fund, just a small temporary fund which will be wiped out this coming biennium. A permanent rainy day fund that is 5% of Oregon GDP is my proposal.