Thanks to all who commented on my challenge
. Big thanks to Nick Rowe especially.
A brief recap: economic models treat the savings decision as a case of inter-temporal substitution -- either I buy now or I buy later. The discount rate governs exactly how this decision is made, and the discount rate includes an inflation term. If inflation expectations increases, then future consumption is discounted more heavily, and inter-temporal substitution begins to favor the present. Or, as Nick says "the increase in expected inflation reduces the real interest rate for any given nominal interest rate"
I don't reject this model because it abstracts reality to illuminate a particular mechanic. That is the point of models. I reject this model because it fails to capture the essential economic dynamic at work here. The inflation expectations story is simply a weak one.
Take this scenario (slightly tweaked, as Nick, while long on generosity was a little short on imagination. Still, all is forgiven, and I do thank him for this list): You're living in Brazil, it's 1970s, you have a stash of cruzieros (your and your family's life savings!!) and you think the value of your nest egg is about to be blow to smithereens via a vicious bout of hyperinflation. In this case, Nick would:
- Buy a variety of luxuries
- Buy some financial assets tied to commodities
- Quit his job (take unpaid leave)
In case you think I'm joking, here's the list, verbatim:
1. A new, lighter weight canoe. Swift Mattawa, in carbon fusion. Better buy it now, before prices rise, rather than waiting till I'm too old to lift my heavier one. (Do you really want the exact model and manufacturer?)
2. Better cookware.
3. Many crates of Scotch.
4. A new field drain under the back yard.
5. New laptop for one daughter.
6. New stereo for the other daughter.
7. Small farm 30 minutes north.
8. shares in oil/gas drilling company.
9. equity mutual funds (have to ask my broker which).
10. One year's leisure (unpaid leave from work, since the money won't be worth as much, and it would be better to take the leisure now and retire a year later).
See, I was not kidding! I think the number of people who, on the eve of having their hard earned life savings obliterated, would blow it on kayaks and scotch is small.
Vivianne Vilar, who it seems has personal experience, nails it:
My mum (and all family) used to buy dollars. I can't tell you about 1979, because I was only born 2 years later, but that is what she did from when I was a kid until 1994, when the Plano Real was implemented.
Primarily, people save for things:
1. They cannot afford currently (and don't want to buy on credit)
2. Unexpected emergencies
3. Old age
4. Bequests for their kids
2-4 cannot be moved forward
and so are not inter temporal decisions the way the models treat them. Therefore, if savings are threatened, people will substitute into other stores of value such as fx or gold. They will not move consumption forward, as they cannot. This is not about consumption.
1 is an interesting case. If there's something you cannot afford now, you will not go out and buy it because you'll be able to afford even less of it in the future. There is one big exception to this, which I'll write about in a future post.
Ultimately, you need to decide for yourself whether, if your nest egg is going to be hyper inflated away, you'll spend it on a fiber glass kayak or move your savings to another currency. Economists are betting on the kayak.
Labels: savings economics