The Shortage/Glut of Savings: The Which Way Is Up Problem in Economics

September 01, 2021

The release of the new Social Security Trustees Report, coupled with a New York Times article on what strikes me as a rather silly debate on inequality, led me to think again about the lack of self-reflection in economics. We have seen a 180 degree turn in the understanding of one of the most basic economic problems, yet there is almost no one anywhere saying something to the effect of “yeah, we got that wrong, and here’s why.”

I’ll get to the contradiction in a moment, but first I want to explain why I think the debate which was the focus of the Times article is rather silly. The essence of the debate in the Neil Irwin piece (the Times reporter who wrote the article) is over whether inequality is leading to lower interest rates, which generates greater wealth inequality, or whether the big problem is the low interest rates themselves causing wealth inequality.

To my mind, this is a silly debate, starting with the idea that we should be concerned about inequalities in wealth resulting from low interest rates. That one is a bit hard for me to see.

Just to be clear, there is no doubt about the relationship between interest rates and wealth, as traditionally defined. Low interest rates increase the value of assets like houses, stocks, and bonds. In the last case, the relationship is literally definitional. If a very long-term bond pays a $10 a year coupon, it will be worth roughly $250 when the long-term interest rate is 4.0 percent, but $500 when the rate is 2.0 percent. The question is whether we should be bothered when all the rich people see their stocks, bonds, and to a lesser extent homes, double in price when interest rates plunge.

I know this provides a lot of grist for academic papers, and for foundations who are ostensibly concerned about inequality, but I just have a hard time seeing the problem here. Part of the story is that I sort of doubt that any of these people will be celebrating the reduction in inequality if things went the other way – we saw a sudden surge in interest rates and the stock market fell 50 percent (the celebrants weren’t very visible in the 2008-09 crash).

But the bigger problem is that I just see their accounting as giving a very incomplete picture of wealth. For the vast majority of middle-income people, wealth reflects the ability to meet needs they face in their lifetime. They accumulate wealth in order to cover the cost of their retirement, their health care expenses, especially in old age, and their kids’ education. Middle class people rarely accumulate any substantial sums beyond these needs.

If it’s not already evident, these needs are also often met by government-provided social insurance, like Social Security, Medicare, and, in countries other than the United States, publicly supported colleges and universities. In effect, for middle class people, social insurance provides a direct substitute for wealth.

In many cases, this substitution is quite explicit. In a country with a high wage replacement rate for its Social Security program, workers don’t need to accumulate large amounts of wealth in 401(k)s to support themselves in retirement.  The same is true if public health care programs can be counted on to pay their health care expenses. And, they don’t need to save for their kids’ college if it’s free or cheap.

We could of course count these benefits as “wealth,” but then the story of low interest rates causing inequality would largely disappear. Middle class workers would see the value of their Social Security and retirement health benefits soar when interest rates plummet, in the same way that bond prices soar. The whole problem of interest rates causing inequality then disappears.

Okay, but I don’t really want to destroy the basis for a major academic debate, just noting why I don’t see the problem. (I also have a hard time seeing it as an inequality problem when tens of millions of middle-income homeowners are able to save thousands of dollars a year on their mortgage, car, and credit card payments. But, that’s just me.) Anyhow, let’s get on to the bigger question.


Do We Save Too Much or Too Little?

This really should be a joke, but it is now a central question in economics. The reason why this should be a joke is that the answers give images about the economy that are 180 degrees at odds with each other.

The saving too much story is that we don’t have enough demand in the economy. If our main economic problem is that we save too much, then we help the economy, meaning we will have more growth and employment, if we spend more money. If we are in this world, we should worry that budget deficits are too small, not too large. We should be very happy to give low and moderate-income families additional money to support their kids and to ensure they have a decent living standard. (We should be happy in any case, but if our problem is that we save too much, then this money doesn’t have to be a trade off against other spending. We aren’t up against any constraint, so there is no reason not to make these payments.)

President Biden’s investment proposal looks especially good in the saving too much story. If the problem is that we don’t have enough spending in the economy, why wouldn’t we make whatever expenditures are necessary to quickly create the infrastructure for a green economy, as well as providing workers and businesses with subsidies to encourage them to quickly shift to electric cars and trucks, and clean energy sources for their homes and businesses.

And of course, we should want to improve the skills of the workforce by supporting free community college for the short-term and pre-K and child care for the longer term. And, we also should shore up our care-giving economy, with increased support for home health care and other forms of care for seniors and the disabled as well as improving the pay and working conditions for those employed in the sector.

If our economy’s main problem is that we are saving too much, we essentially have a green light to address all sorts of problems that have lingered for decades. The saving too little story is the complete opposite. If this picture is accurate, then we are pushing up against the economy’s limits to produce goods and services. The only way we would be able to spend any substantial sum on the agenda laid out by President Biden is by sharply curtailing spending in other areas of the economy. This typically means raising taxes to reduce the money households or corporations have, and therefore force them to cut back their spending.

While it’s a bit hard to tell the saving too little story today, with the interest rate on long-term bonds hovering near 1.3 percent, it really has been central to economics for many decades. This was the whole rationale for cutting the deficit and balancing budgets in the 1970s, 1980s, 1990s, 2000s, and the last decade. The idea was that our budget deficits were pulling resources away from other sectors of the economy that could better use them than the government.

And, the lack of savings story went far beyond just budget deficits. It was also the motivation for all the supply-side tax cuts, starting with Carter cutting the capital gains tax in 1978, Reagan’s huge tax cuts in the 1980s, George W. Bush’s tax cuts in 2001, and Trump’s tax cut in 2017. All of these tax cuts disproportionately gave more money to the wealthy with the argument that a large share of the cut would then be saved, which would free up resources for investment.

Conservatives also took their savings obsession in the other direction. Martin Feldstein, spent his career trying to show that Social Security reduced private savings. The argument was that typical workers saved less during their working years due to Social Security, which meant that there was less investment than would otherwise be the case, and therefore we were all poorer. His answer was to cut benefits, or better yet, privatize a large chunk of the program.

But, if we were saving too much, then increasing saving with tax cuts (they don’t seem to have had that effect) or cutting Social Security or other benefits, would be taking us in the completely wrong direction. It would mean further reducing demand and employment, and likely also reducing investment, which tends to follow the growth in demand.

We could of course have been saving constrained in prior decades, but not in recent years. This gets to the debate covered by Irwin. One side argued that we have too much savings now because we redistributed income upward, and rich people spend a smaller share of their income.

The other side sees the issue as primarily demographic. We, and other wealthy countries, now have older populations, and older people save a larger share of their income than younger people. In that view, we have a scary road ahead as our population ages further, and even many developing countries, most notably China, are seeing a rapid growth in the share of retirees in their population. So apparently, we are doomed to have too much savings for the indefinite future.

Will Large Numbers of Retirees Break the Bank or Leave the Stores Empty?

This is the point in the story where I have to pause for a little ridicule. The whole deficit debate of the 1980s, 1990s, and 2000s was framed in the context of the looming retirement of the baby boomers. The story as told by Very Serious People, like Peter Peterson and the many organizations he funded, was that the economy would be overwhelmed in meeting the demands of retired baby boomers, at the same time it was providing for needs of its working population and their children.

And, this was not just the perspective of a fringe group. This concern with providing for the needs of retired baby boomers was very much at the center of national politics and the economics profession. This was the whole logic behind Bill Clinton’s balanced budgets and his plan to pay off the debt, touted by leading economists such as Larry Summers. It was also the concern that ostensibly motivated the drive to balance the budget under President Obama and his search for a “Grand Bargain.” And, it was worldwide, as we can see from the World Bank’s volume Averting the Old Age Crisis.

Given this history, we should have a lot of Very Serious People walking around with very serious egg on their face. The view, now widely accepted, that having an older population doesn’t mean too much demand, but rather too little, means that the concerns that had dominated politics here and elsewhere for decades were completely unfounded.

There was no reason to cut back spending on child care, education, clean energy, and thousands of other items in the last two decades with the idea that we somehow would need a larger capital stock to cover the cost of baby boomers retirement. (Okay, that never made much sense in any case.) The Very Serious People not only got the magnitude of the problem created by an aging population wrong, they got the direction wrong.

Policy types can again be thankful that policy work is not like cleaning toilets or washing dishes, where you can get fired for doing bad work. In fact, for the most part getting the story completely wrong will not even be held against you on your career path.  



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