« Pre- Darwinian Macroeconomics | Main | "The most severe recession since the last one!" Or, how Canadian economic forecasters got it right »

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

I think from the fed's flow of funds it is the federal gov't going further into debt.

Link:

http://www.federalreserve.gov/releases/z1/Current/z1.pdf

Page 6 of document ; page 14 of pdf

Page 8 of document ; page 16 of pdf

I might be able to find some other links.

Sorry if this is a repeat.

I think from the fed's flow of funds it is the federal gov't going further into debt.

Link:

http://www.federalreserve.gov/releases/z1/Current/z1.pdf

Page 6 of document ; page 14 of pdf

Page 8 of document ; page 16 of pdf

I might be able to find some other links.

"People who argue that too much debt got us into this mess, and low interest rates just encourage more borrowing and more debt, and are a dangerous "hair of the dog" remedy, are hopelessly conceptually confused. But they might nevertheless be right (by sheer accident) if the people doing the extra spending are debtors, rather than creditors."

IT IS NOT AN ACCIDENT!!! Maybe a flea in the "hair of the dog"?

Ever hear of the greenspan "put"? Should it really have been called the greenspan lower and middle class debt "put" (that is "tricking" the lower and middle class into going further into debt to the rich to prevent price deflation from occurring)?

"If debtors do all the extra spending, debt rises."

That sounds better. Has that been happening since around 1980 to 1982?

(Federal) governments are debtors, and governments (around the world) have increased spending, and so government debt (more importantly, government debt/income ratios) are expanding, which is clearly unsustainable in the long run. But that point has generally been recognised. And we are still a long way from the prudential limit there.

I was thinking more of individuals.

Individual spending is related to income/wealth, and creditors' income is inversely related to interest rates (earn less on the funds they lend). So, as long as this effect is larger than the lower incentive to lend in the first place due to the lower rates, they will spend less. The reverse holds debtors. What's wrong with this logic and if we are to look for data to shed light on this question it might help to know where this simple story goes wrong.

Another thought: consumer durables are a form of savings for an individual creditor with a given (utility) rate of return. As interest rates falls, could it be that creditors just shift their composition of lending to favour accumulation of durable goods (the "I'll buy that new fridge now" effect)?

Nick, wouldn't this be somewhat a story of how individuals in China (creditors) and the USA (debtors) are behaving? Roughly of course. It seems that the savings rate has jumped in the US, but has it fallen much in China? I suppose it's difficult to get reliable Chinese data.

Coming out of a credit crisis, I would think that both borrowers and lenders would be increasing their spending relative to the lows experienced during and immediately following the credit crisis.

I've got another right question to ask.

Define "extra" as in "extra spending".

Trevor: good point on income effects. Let's see. Ignore substitution effects. Ignore the difference between transitory and permanent income. If interest rates fall, debtors have higher disposable (net of interest) income, and creditors have lower disposable income. So if spending is proportional to income, debtors spend more and creditors spend less. BUT, since their disposable (net of interest) incomes have changed too, the effect on saving and dissaving, borrowing and lending (and hence debt) is ambiguous. It depends which group (debtors or creditors) has the higher marginal propensity to save. Now clearly debtors must have had a lower average propensity to save in the past, otherwise they wouldn't be debtors now. But I don't think that tells us anything about the relative MARGINAL propensities to save NOW, of debtors and creditors. Or does it?

Spending on durable goods is exactly the sort of spending we would expect to be most affected by lower interest rates. And creditors switching from lending to instead spending on durables is exactly the sort of effect we want. But then debtors might also do more spending on durables if interest rates fall. Which group responds more?

Andrew: The China/US story is very much part of this question. And if what we seem to be hearing is correct (China spending more; US less) that's good news. Very aggregate though, obviously. It doesn't tell us who is spending less in the US.

Westslope: If both debtors and creditors increase spending by the same amount, that helps recovery, and incomes rise, and there should be no effect on debt (and the debt/income ratio should fall, which is good news).

anon: yes, I wasn't very clear on what "extra" should mean. I should have defined it the same way I defined "rise" and "fall" for debt: extra means relative to what would have happened otherwise. We can perhaps take the immediate past as a proxy for what would have happened otherwise.

Sorry, I think the counterfactual is too ill defined and indeterminate.

You've got actual GDP growth relative to something else, and actual gross debt growth relative to something else. How do you know either counterfactual, let alone the combination of the two as a counterfactual? You need to know what gross debt growth would have done in whatever GDP counterfactual you choose. Then you need to correlate that with spending by debtors and creditors. Apart from that, you won't get anything by looking at aggregate balance sheets because net debt always sums to zero.

Maybe one way of framing it is to somehow get a hold of distribution of changes in net saving across households, according to their existing net debt or creditor positions. That's impossible, in the sense it couldn't realistically be available as a statistical coordinate.

Brad Setser use to have nice charts on how government debt was increasing but by less than private debt was falling and the increase in savings was actually a reduction of debt and trade imbalances were falling but as this would all be very dynamic, I am not sure they are continuing to improve or reversing. These would all be aggregate and circumstantial but were leaning positively a while ago.

I don't know Nick, but it's great to have you back posting.

Well, as someone who argues that 'too much debt got us into this mess, and low interest rates just encourage more borrowing and more debt, and are a dangerous "hair of the dog" remedy', I certainly don't feel hopelessly conceptually confused, nor did I find the linked post particularly convincing.

Nor, if this view turns out to be accurate because interest rate decreases cause debtors to increase their spending more than creditors, will that be 'sheer accident', rather it is a central part of the argument (the 'low interest rates encourage more borrowing and more debt' part). It's not an accident when you are right because what you thought would happen turned out to actually happen. I certainly could be wrong, or right for the wrong reason, but not if I'm right for that reason.

Let's look at the debtor side first. It seems pretty clear to me that there are a lot of people whose borrowing is only constrained by their cash flow, meaning that as interest rates decline, they will spend more if they are able (see Vancouver housing market for gory evidence).

On the creditor side, from your previous posts I would have expected you to hold the opinion that if creditors tried to start spending instead of lending, that would have the effect of driving up rates - meaning that the absence of pressure to increase rates that we currently see signifies that creditors are happy to keep lending and are not increasing their spending instead.

Personally, I feel that the rates are controlled more by the central bank than by depositor 'lenders', but regardless I'd be surprised if creditors reacted to an interest rate cut that decreased their income by spending more. If anything, I'd expect them to spend less in order to make up for the lost savings. Even if (some of them) did increase their spending, the new spending might just subdivide the existing creditors into new debtors and bigger creditors, without affecting the existing debtors - adding even more debt.

If the last 20 years has proven anything in my mind, its that reductions in interest rates lead to higher debt levels, not lower debt levels.

If we want to reduce debt levels, they have to be tackled more directly. Some options:
1) Trigger inflation
2) Increase the number of defaults (increasing interest rates would 'help' here)
3) Increase debtors incomes (higher minimum wage, stronger unions, trade barriers that prevent global wage arbitrage, etc.)
4) Transfer money directly from creditors to debtors (progressive taxation, easing of bankruptcy rules)

Some of the things we wouldn't want to do.
1) Allow deflation (unless it was a liquidationist debt deflation that caused widespread bankruptcy)
2) Prevent defaults from occurring (via lower interest rates, tougher bankruptcy laws)
3) Allow proliferation of 'marginal' payday lenders / deregulate finance industry
4) Have government go further into debt to give money to creditors
5) Bribe people to take on more debt via car and house purchases (cash for clunkers, home purchase grants, etc.)
6) Transfer less money from creditors to debtors (lower income tax rates, lower corporate tax rates, lower taxes in general)
7) Increase creditor incomes relative to debtors (globalization, free trade, stagnant minimum wages etc.)

Given those lists, its clear enough to me that all forces are working towards more debt with none working towards less debt - it's not a surprise we're in the mess we're in.

anon: "Maybe one way of framing it is to somehow get a hold of distribution of changes in net saving across households, according to their existing net debt or creditor positions. That's impossible, in the sense it couldn't realistically be available as a statistical coordinate."

That's exactly the data that would be lovely to have! Why is it impossible to have it? Survey data, in principle, could work.

Don: Thanks! It's great to feel my mind thinking about economics again, and being able to concentrate for an hour or two, rather than juggling the dozens of things I've been administering.

Lord: yes, good thought. Looking at trade balances for debtor and creditor nations would give us what we need at the aggregate level.

Declan: If you have a *theory* of why a fall in interest rates would impact savings/spending of debtors differently from creditors, and can use that theory to explain why both borrowing and lending would increase, then agreed, you are not one of the "hopelessly conceptually confused". Not sure if I understand your theory though.

Off canoeing. Back in a few days.

About excess savers, the savings rate, and wealth/income inequality, see this link:

http://www.nakedcapitalism.com/2009/08/guest-post-the-savings-rate-has-recoveredif-you-ignore-the-bottom-99.html

"Fortunately, there IS some pretty good data on income stratification in the United States, and a few assumptions can help shed some light. Economists Thomas Piketty and Emmanuel Saez have made careers of studying US income inequality using IRS data, which goes back to 1913. The most recent data available (for 2007) showed that the top 14,988 households (0.01% of the population) received 6.04% of income, the highest figure for any year since the data became available. The top 1% of households received 23.5% of income (the second highest on record, after 1928), while the top 10% received 49.7% of income (the highest on record)."

And, "If we expand our survey to the top 1% of all households, we find an average income of $1.36 million for 2007. These folks had an average federal tax burden of just under 33%, so their after tax income averaged $916 thousand. If you assume this group had a savings rate of 33%, you get total savings of $452 billion (remember, $171.5 bn of this comes from the top 0.01%, we’re assuming a savings rate of around 25% of after tax income for the “poorer” 99% of the top 1%) This is more than 100% of the personal savings of the entire population, according to the BEA data. It implies that 99% of the US population still has, on average, a negative savings rate of around 1.3%. If you subtract the next nine percent, which likely still has a positive savings rate, the data for the bottom 90% becomes even more depressing, implying a negative savings rate of close to 5%."

Back to the apples:

Nick, you need to break your "apple income" down into at least corporate income and wage income.

What does the model look like if productivity and/or cheap labor shift the supply curve for apples to the right, the fed adds bank reserves to shift the supply curve of loanable funds so that interest rates come down, the workers have a price inflationary attitude of 2% per year for apples and overestimate their permanent wage income (expectations are too high) so that they borrow using bank loans denominated in currency (NOT APPLES) based on that overly optimistic permanent wage income leading to the demand curve for apples being shifted to the right?

In the end, does the "apple corporation" get operating margin growth, quantity growth, and price inflation?

Do the workers get negative real wage growth and more bank loans denominated in currency, and the "apple corporation" gets positive real corporate income and possibly excess savings?

Does that scenario lead to more wealth/income inequality?

About middle class debt and from:

http://latimesblogs.latimes.com/money_co/2009/08/the-well-heeled-might-be-able-to-save-the-us-economy-from-a-long-period-of-dismal-consumer-spending----if-only-we-dont.html

'The consumer isn't overleveraged -- the middle class is'

See this chart:

http://latimesblogs.latimes.com/.a/6a00d8341c630a53ef0120a4f32ae0970b-pi

And, "What the report doesn't address is the question of what kind of recovery would be preferable, if we're able to choose: If you want a more broad-based rebound in consumption -- as opposed to heavy spending by the wealthy on what might be a relatively limited range of big-ticket goods and services -- doesn’t it make more sense to favor economic and tax policies that bolster the finances of middle- and lower-income folks, even if that’s at some cost to the better-off?"

About debt and inequality:

http://rortybomb.wordpress.com/2009/08/04/debt-and-inequality/

Here is one quote: "Now remember our original assumptions: Income inequality is large. Consumption inequality is smaller. So savings inequality must be huge."

Flow of Funds March 2009 charts:

http://www.itulip.com/forums/showthread.php?t=8673

'


Flow of Funds Q4 2008 charts:

http://www.itulip.com/forums/showthread.php?p=83348

Declan and I are pretty much on the same page.

Declan said: "Personally, I feel that the rates are controlled more by the central bank than by depositor 'lenders',"

For Nick and Declan, isn't price inflation one detriment of interest rates???

From Nick's post:

"Declan: If you have a *theory* of why a fall in interest rates would impact savings/spending of debtors differently from creditors, and can use that theory to explain why both borrowing and lending would increase, then agreed, you are not one of the "hopelessly conceptually confused". Not sure if I understand your theory though."

How about negative real earnings growth and more and more debt (loans denominated in currency) to maintain a standard of living for the lower and middle class along with extremely positive real earnings growth for the rich who don't spend more but "recycle" excess savings into assets (including debt)? Plus, would excess savers be willing to leverage (loans to speculate in financial assets) anticipated asset gains (mostly stock prices and housing prices) from the more debt on the lower and middle class when interest rates are low?

One other thing. IMO, someone who makes $150,000 per year or more and only spends $100,000 a year is not going to spend more because interest rates come down. Would lower interest rates cause them to buy riskier assets? Maybe (think buying housing debt instead of treasuries)?

Back to interest rates.

From what I have seen, interest rates are determined by price inflation and real GDP. They are also determined by the likelihood of default and someone willing to buy the bond.

Currency fluctuations are probably a consideration too.

Wouldn't the simple way to determine the answer simply by looking at debt levels. I haven't seen numbers for Canada, but in the US, debt have been falling, suggesting that it is indeed creditors who are increasing spending.

Neil's simple answer may be the right one.

In Canada, bank debt seems to be rising. But I don't know if this is because banks are taking over the role that non-bank borrowing and lending used to play (i.e people lend and borrow via banks, rather than directly).

Another problem is that if a person both borrows more and lends more, that person's gross debt will rise, even if his net debt does not.

Too much Fed:

Suppose variance in savings across individuals is huge. That doesn't tell us what we want to know. We want to know the *covariance* between savings and net debt, across individuals. Is it positive (good news), or negative (bad news)?

At the back of your mind, I think, is a theory that says that an individual's consumption is unrelated to his income. So changes in income have no effect on consumption, only on savings, $1 for $1.

Declan: Coming back to your theory: I think this is the key part of your theory: "Let's look at the debtor side first. It seems pretty clear to me that there are a lot of people whose borrowing is only constrained by their cash flow, meaning that as interest rates decline, they will spend more if they are able (see Vancouver housing market for gory evidence)."

Let me re-state it in my own terms (hoping I'm not distorting what you say too much).

There are two types of people: some are the rational sorts of people of economic theory, who save or dissave depending on whether their current income is high or low relative to expected future income, on whether interest rates are high or low, etc. And others just borrow and spend everything they can get their hands on. The first group will contain creditors and debtors. The second group will all be debtors.

If interest rates fall, (damn, I've forgotten the proper word!) the maximum amount of debt you will be allowed to carry will be higher. So the second group will save less and borrow more. And they are all creditors. If the second group is a large enough percentage of the population, it will swamp any effects in the first group (which could go either way).

If I have described your theory more or less accurately, I think it makes good logical sense. Whether it's factually right is a separate question, but it sounds plausible to me.

(What you say about interest rates further down isn't quite right, since you have ignored what happens to income when aggregate spending increases, but that doesn't affect your argument above.)

Let me put forward a variant of my first interpretation of Declan's theory:

Everybody is rational in their consumption/savings decisions. But some people find themselves borrowing-constrained when they try to implement their rational plan. The borrowing constrained will all be debtors. A fall in interest rates reduces carrying costs of debt, and so relaxes the borrowing constraints. If the borrowing-constrained are a big enough percentage of the population, that effect will swamp any effect on the borrowing-unconstrained. So debtors will increase their spending more than creditors.

Nick said: "Suppose variance in savings across individuals is huge. That doesn't tell us what we want to know. We want to know the *covariance* between savings and net debt, across individuals. Is it positive (good news), or negative (bad news)?"

Could you explain that one a little more?

Dunno if this actually answers the question in the title, but it may be consistent with a story in which the answer is 'creditors':

"Consumer credit decreased at an annual rate of 10-1/2 percent in July 2009. Revolving credit decreased at an annual rate of 8 percent, and nonrevolving credit decreased at an annual rate of 11-3/4 percent."

Presumably these people are also net debtors.

Too Much Fed

Too Much Fed

Nick's post said: "At the back of your mind, I think, is a theory that says that an individual's consumption is unrelated to his income. So changes in income have no effect on consumption, only on savings, $1 for $1."

Partly. Think about the apples. The workers make $30,000 a year and want to spend $40,000 a year believing they will get 3% wage increases in the future and that apples will increase by 2% per year so they borrow more if interest rates come down.

The upper management at the apple corporation and most of the shareholders are making $150,000 per year or more and spending only $100,000 per year, saving the rest.

All borrowing for the workers is loans denominated in currency based on current/future wage income.

A productivity and/or cheap labor shock happens, but the workers are told by their politicians that things will get better and we are fighting price inflation so the workers go on borrowing even though real earnings are getting closer to negative in real terms. Eventually, the workers wages go negative in real terms so they borrow against their houses or stocks because they are having trouble meeting the interest payments even with lower rates. Eventually, that does not work either when asset prices fall because of trouble meeting the interest payments. BAM! Debt deflation sets in with defaults. This borrowing has increased aggregate demand.

On the other hand, the apple corporation has experienced positive real earnings growth (corporate profits). With pricing power, quantity power, and operating margin expansion, it will increase supply and may borrow (loans denominated in currency) based on the corporate profits.

Notice there was a "spiraling up" of aggregate demand and aggregate supply based on the loans. As long as the workers experiencing negative real earnings growth kept on borrowing, to a lot of people it looked good (low price inflation, low interest rates, some more employment, and HIGH asset prices).

It wasn't!!!

IMO, there are two(2) morals to the story.

1) Don't use debt (loans denominated in currency) to attempt to stabilize and grow an economy (the great moderation)

2) Productivity and/or cheap labor shocks should not be met with lower interest rates to attempt to increase debt (loans denominated in currency and future demand brought to the present) on the lower and middle class to prevent price deflation.

I think I left out the "traders" who were speculating on the producer of apples stock price who used cheap debt to leverage. They believed the stock price would go up at least 7% per year when they borrowed cheaply.

May edit later.

Similar to Stephen's:

http://globaleconomicanalysis.blogspot.com/2009/09/consumer-credit-contracts-record-216.html

Stephen:
Thanks. Good find. Yes, it does seem to be consistent with the "good news" answer. Paradoxically, the Wall Street Journal (if you keep clicking through the links, you get to the WSJ story) interprets the same data as "bad news" for a prospective recovery. They seem to buy the "hair of the dog" fallacy that debt=spending, and so declining debt is the same as declining spending, and is bad news for recovery.

Too much Fed: Let me re-state more simply: OK, there are big differences between individuals' savings. Some have positive savings, and some negative savings. But that's not what we need to know. We want to know if there is a positive or negative correlation between savings and debt. In other words, do those with positive savings tend to have positive debt, and those with negative savings negative debt (good news), or is it the other way round (bad news)?

"In other words, do those with positive savings tend to have positive debt, and those with negative savings negative debt (good news), or is it the other way round (bad news)?"

I'm going to assume positive savings means wage income is greater than spending and vice versa. Is that correct?

What is positive debt and negative debt?

How about "Who was increasing their spending - debtors or creditors?"

Lessons From The Fall: Household Debt Got Us Into This Mess

http://www.npr.org/blogs/money/2009/09/lessons_from_the_fall_househol.html

"Our research suggests that the historic growth in household debt preceding the financial crisis was the primary driver of the onset and deepening of the current recession.

The central lesson we as economists have learned from the crisis is that an unsustainable increase in household debt is one of the most serious threats to the U.S. economy."

I SERIOUSLY doubt if anyone at the fed has learned anything from this.

NR: "Low interest rates encourage spending and recovery, but this can mean that debt either rises or falls, depending on who does the extra spending. If debtors do all the extra spending, debt rises. If creditors do all the extra spending, debt falls."

If the creditors are doing "the extra spending", doesn't that sort of imply a situation, where debtors are doing some extra paying back. Don't debtors have to decrease their borrowing and spending to enable lenders to spend instead of lend?

I see how an expanding debt drives more spending. It is less clear to me how shrinking debt is going to drive more spending?

Am I missing something?

I feel certain that I will eventually persuade you to forget "ultimate" lenders and debtors, and embrace the joy of intermediation, where relative, not absolute, interest rates drive lending and borrowing, and the ability to use money, credit and marketable financial assets as insurance dominates.

But, perhaps you are there already, and what you are trying to ask about is leverage?

Toxic assets in the 18th century

http://www.voxeu.org/index.php?q=node/4001

Explaining two trade busts: Output vs. trade costs in the Great Depression and today

Smoot-Hawley

http://www.voxeu.org/index.php?q=node/3998

http://news.yahoo.com/s/nm/20090922/bs_nm/us_usa_geithner_economy_3

Sept. 22, 2009:

"WASHINGTON (Reuters) – U.S. Treasury Secretary Timothy Geithner on Tuesday said that the U.S. economy appeared to be picking up steam and G20 leaders gathering in Pittsburgh this week would strive to ensure the recovery was balanced.

"We are at the very beginnings of this recovery ... We need to make sure that we keep at this, so we have in place a recovery that is going to be self-sustaining, led by private demand, (and) a financial system that can actually provide the credit that is needed," he told a press briefing."

Does "private demand" mean private demand from more debt (loans denominated in currency) on someone somewhere?

The comments to this entry are closed.

Search this site

  • Google

    WWW
    worthwhile.typepad.com
Blog powered by Typepad