Thursday, May 27, 2010

Mark Thoma gets a clue

Bravo to Mark Thoma for cottoning on to something that's been blindingly obvious to the rest of us for years now:
Initially I was critical of how the tax cuts were targeted since so much ended up going to saving rather than consumption. This is the part I am rethinking.

There are different types of recessions, and this one can be termed “a balance sheet” recession. It had a big impact not just on bank balance sheets, but on household (and, for that matter firm) balance sheets as well. Households were particularly hard hit due to declines in stock prices and declines in the value of housing. These losses were large, they upset plans for things such as retirement, and households needed to refill the holes in their balance sheets that had been created (this includes paying off debt).

How do they refill their balance sheets? By saving more and consuming less (paying off debt is a form of saving). Thus, as the recession took hold, we saw a large increase in the saving rate and a corresponding fall in consumption. The tax cuts were an attempt to reverse the decline in consumption, but instead they mostly raised the amount that went into saving.

But that has a benefit. Households are not going to start consuming normally again until their balance sheets are repaired. The faster the holes in their balance sheets are refilled, and tax cuts can help with this, the faster the households can return to their normal rates of consumption — a prerequisite for the economy to return to normal.
I shouldn't be too hard on him though, he's an academic economist and therefore handicapped in understanding household behavior, finance, and the economy. Still, this is excellent progress!

5 Comments:

Blogger Tom Hickey said...

I shouldn't be too hard on him though, he's an academic economist and therefore handicapped in understanding household behavior, finance, and the economy. Still, this is excellent progress!

The GFC and "balance sheet recession" (coined by Richard Koo) has been a wakeup call to a lot of economists, who now realize that they had not paid enough attention to the role of finance. Moreover, they didn't understand finance well, either. Apparently never bothered to study it very deeply, since markets are only barter systems writ large. That didn't work out so well for them.

9:00 AM  
Blogger winterspeak said...

And they're too arrogant to pay attention to Accountants

9:04 AM  
Blogger STF said...

The MMT view of this is shown visually in figure 10 here if anyone wants a graphical representation of the point:

http://neweconomicperspectives.blogspot.com/2009/07/sector-financial-balances-model-of_26.html

9:17 PM  
Blogger Ohm (Ώ) said...

~ "Homes and Businesses are repairing their balance sheets by paying down debt" - that's why the monetary stimulus isn't creating fresh investments and jobs on the Mainstreet, only Gold rallies, and until recently, in stocks.

The need of the time is Public Investments; from roads and bridges to Education.

9:00 PM  
Blogger winterspeak said...

Ohm: In my neighborhood, I see perfectly good roads being torn up and repaved, while brain injured children see their services cut. And while spending per pupil has skyrocketed since the 50s, the quality is much lower. Theoretically, spending could be well targeted. In practice, we see "infrastructure" repeated as if we were in the 1930s, and the politically connected at the trough as per the usual.

I have a recent post on the negatives of stimulus as currently implemented.

3:34 PM  

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