We descendents of Swiss immigrants have strong saving ethics. After all, income not spent on consumption can be saved and invested. At the macroeconomic level, savings provide the pool from which financial institutions lend for investment.
So saving is essential at both the individual and macroeconomic levels. But wait a minute - economists are saying that our newly acquired affinity to save is making the recession worse.
What gives? If saving is good, how can it make the recession worse?
Both statements are true - it's a matter of context. The great economist, John Maynard Keynes, explained this apparent dilemma through "the paradox of thrift." Let's take a closer look at this concept and see how it relates to our current recession, and its policy implications for getting out of this jam.
Gross Domestic Product (GDP) is the gross market value of all goods and services produced within the nation's borders in a year. It has four components: Personal consumption, private investment, government purchase of goods and services, and net exports. These components represent "spending," and as a real life Schweitzer, I don't even like that word.
But let's face it - spending generates income as wages, rents interest, and profits out of which expenditures are made and savings accumulated. Economists refer to this as the circular flow of income.
So what does this have to do with recession? If the level of spending is not sufficient to fully utilize the productive capacity of our economy, we will have unemployment. Unemployed workers further reduce spending. Those fortunate enough to have jobs, but fear losing them, reduce their spending and increase saving - a rational response.
Where does the paradox come in? Increased saving means reduced expenditures circulating throughout the economy, thereby reducing income from which to save. Hence, the paradox.
But aren't these increased savings available for investment? They are, indeed, potentially anyway. But as Keyenes pointed out, saving and investment decisions are not made by the same people. In a depressed economy, lenders may not be willing to lend and the business sector may not borrow if consumers don't have the income, or are not willing to spend it. Sound familiar?
The necessary policy measure then is - I hate to say it - to increase spending. But how? And wasn't it irresponsible lending, borrowing and spending that was at least partially responsible for this jam in the first place?
Unemployed workers cannot increase spending, and employed workers are well advised to save. Businesses cannot be expected to increase spending in a depressed economy. And we cannot significantly increase exports in a depressed world economy.
That's why the federal government is "spender of last resort" - to increase demand for domestic goods and services in a way to increase JOBS and get us back on an upward spiral.
Why can't this be done through the private sector by giving incentives to business to produce more, as advocated by "supply side" economists? Because in a depressed economy supply is not the problem. If consumers can't buy the product, businesses will not hire additional labor to produce.
What about monetary policy - lowering interest rates as an incentive to borrow, as during the '90s and early '00s? The same reasoning applies. If the business sector doesn't see the demand, lenders may not lend and businesses may not borrow, even at low interest rates. Monetary policy can work if the economy is functioning at or near full employment. Our current anemic economy calls for stronger medicine.
But can't consumer spending be stimulated through tax cuts? Tax cuts can help if targeted to the working poor and middle-income people who pay more in Social Security taxes than income taxes. But if the objective is to rapidly and surely increase spending, and thereby employment, on a sustainable basis most economists agree that direct government spending is more effective than tax cuts. Here's why.
A tax cut increases disposable income, some of which will be saved - again, a rational response, and responsible money management. But that does not provide the immediate economic punch that is sorely needed in this economy. Furthermore, some - perhaps much - of what is spent will be on imports produced abroad, further reducing the economic punch of a tax cut. Compare this to direct spending, for example, on highway and bridge construction projects that immediately employ labor, create demand for materials and a multiplier effect to purchase construction equipment from Deere and Caterpillar, and additional jobs in businesses that sell stuff to these workers who now have money to spend.
There is a tremendous backlog of projects relating to highways, bridges, light rail, water supply, waste treatment and related projects that are financed through the public sector, but employ private firms. Many public buildings need to be made more energy efficient. We need additional public investment in many areas of research and technology. All these items would provide immediate and sustainable employment, while making our nation more productive, competitive and efficient. In other words, we can attend to these long-neglected needs and jump-start our economy at the same time.
But won't this increase the public debt? Yes, at least temporarily. But with a more productive, fully employed economy, the debt will shrink relative to the size of an expanding economy.
Is it fair to "hand to our kids a larger public debt?" It's better to hand our kids a fully employed, competitive economy than a sick economy. Expenditures that make our economy more productive and competitive are not "generational theft," as some critics suggest.
Will such a stimulus package cure our economy? By itself, no. There were a lot of factors that got us into this jam and they all need to be addressed.
To be continued:
- Monroe resident John Waelti is former Professor of Applied Economics, University of Minnesota; and Professor Emeritus, New Mexico State University.He can be reached at jjwaelti@charter.net.
So saving is essential at both the individual and macroeconomic levels. But wait a minute - economists are saying that our newly acquired affinity to save is making the recession worse.
What gives? If saving is good, how can it make the recession worse?
Both statements are true - it's a matter of context. The great economist, John Maynard Keynes, explained this apparent dilemma through "the paradox of thrift." Let's take a closer look at this concept and see how it relates to our current recession, and its policy implications for getting out of this jam.
Gross Domestic Product (GDP) is the gross market value of all goods and services produced within the nation's borders in a year. It has four components: Personal consumption, private investment, government purchase of goods and services, and net exports. These components represent "spending," and as a real life Schweitzer, I don't even like that word.
But let's face it - spending generates income as wages, rents interest, and profits out of which expenditures are made and savings accumulated. Economists refer to this as the circular flow of income.
So what does this have to do with recession? If the level of spending is not sufficient to fully utilize the productive capacity of our economy, we will have unemployment. Unemployed workers further reduce spending. Those fortunate enough to have jobs, but fear losing them, reduce their spending and increase saving - a rational response.
Where does the paradox come in? Increased saving means reduced expenditures circulating throughout the economy, thereby reducing income from which to save. Hence, the paradox.
But aren't these increased savings available for investment? They are, indeed, potentially anyway. But as Keyenes pointed out, saving and investment decisions are not made by the same people. In a depressed economy, lenders may not be willing to lend and the business sector may not borrow if consumers don't have the income, or are not willing to spend it. Sound familiar?
The necessary policy measure then is - I hate to say it - to increase spending. But how? And wasn't it irresponsible lending, borrowing and spending that was at least partially responsible for this jam in the first place?
Unemployed workers cannot increase spending, and employed workers are well advised to save. Businesses cannot be expected to increase spending in a depressed economy. And we cannot significantly increase exports in a depressed world economy.
That's why the federal government is "spender of last resort" - to increase demand for domestic goods and services in a way to increase JOBS and get us back on an upward spiral.
Why can't this be done through the private sector by giving incentives to business to produce more, as advocated by "supply side" economists? Because in a depressed economy supply is not the problem. If consumers can't buy the product, businesses will not hire additional labor to produce.
What about monetary policy - lowering interest rates as an incentive to borrow, as during the '90s and early '00s? The same reasoning applies. If the business sector doesn't see the demand, lenders may not lend and businesses may not borrow, even at low interest rates. Monetary policy can work if the economy is functioning at or near full employment. Our current anemic economy calls for stronger medicine.
But can't consumer spending be stimulated through tax cuts? Tax cuts can help if targeted to the working poor and middle-income people who pay more in Social Security taxes than income taxes. But if the objective is to rapidly and surely increase spending, and thereby employment, on a sustainable basis most economists agree that direct government spending is more effective than tax cuts. Here's why.
A tax cut increases disposable income, some of which will be saved - again, a rational response, and responsible money management. But that does not provide the immediate economic punch that is sorely needed in this economy. Furthermore, some - perhaps much - of what is spent will be on imports produced abroad, further reducing the economic punch of a tax cut. Compare this to direct spending, for example, on highway and bridge construction projects that immediately employ labor, create demand for materials and a multiplier effect to purchase construction equipment from Deere and Caterpillar, and additional jobs in businesses that sell stuff to these workers who now have money to spend.
There is a tremendous backlog of projects relating to highways, bridges, light rail, water supply, waste treatment and related projects that are financed through the public sector, but employ private firms. Many public buildings need to be made more energy efficient. We need additional public investment in many areas of research and technology. All these items would provide immediate and sustainable employment, while making our nation more productive, competitive and efficient. In other words, we can attend to these long-neglected needs and jump-start our economy at the same time.
But won't this increase the public debt? Yes, at least temporarily. But with a more productive, fully employed economy, the debt will shrink relative to the size of an expanding economy.
Is it fair to "hand to our kids a larger public debt?" It's better to hand our kids a fully employed, competitive economy than a sick economy. Expenditures that make our economy more productive and competitive are not "generational theft," as some critics suggest.
Will such a stimulus package cure our economy? By itself, no. There were a lot of factors that got us into this jam and they all need to be addressed.
To be continued:
- Monroe resident John Waelti is former Professor of Applied Economics, University of Minnesota; and Professor Emeritus, New Mexico State University.He can be reached at jjwaelti@charter.net.
