Personal saving rose again in the second quarter. “Does this mean the stimulus tax cut has failed, as the 2008 tax cut stimulus did?”, asks The National Journal.

My answer:

Martin Feldstein and others predicted that the tax-cut component of the 2009 fiscal stimulus package would have substantially less expansionary bang-for-the-buck than the spending component of the package, because much of the tax cut would be saved, as had been the case with the 2008 tax cut.  (“Bang for the buck” in this case could be defined as demand stimulus divided by budget cost.)   We knew this from Milton Friedman’s permanent income hypothesis, or even from good old Keynesian multiplier theory.

But in February President Obama had to get those last three (Republican) votes to pass the stimulus bill in the Senate, and those three Senators insisted on raising the tax cut component of the stimulus package a bit and lowering the spending component. Their motivation presumably was to mollify their fellow Republicans, many of whom still claim that ONLY tax cuts provide stimulus, and that spending does not (and perhaps even has a negative effect) — which is even more extreme than the claim that a tax cut creates stimulus equal to spending. After the failures of the Bush tax cuts (and Reagan’s before him), I don’t know if any economists still cling to such “supply sider” notions — or indeed if these congressmen would be able to state their logic. Regardless, I think the Feldstein prediction has been borne out since then.   Talk about irony!   The Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 were both explicitly designed to boost saving — hence their focus on capital income and higher income brackets — and yet in both cases private saving fell in their aftermath.   The tax cuts of January 2008 and February 2009 were both explicitly designed to boost consumption; yet private saving rose in their aftermath !   

Fortunately, the majority of the Obama stimulus package took the form of increased spending, much of which has yet to come.

None of this is to deny that efficiency is an important consideration, and cost-benefit calculations should always enter into the choice of both what kind of tax cuts to adopt and what kind of spending increases to adopt. But if it is short-term demand stimulus we are after, and we are, then government spending gives more bang for the buck than tax cuts.

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“Is the recent Return to Saving temporary or permanent?” asks the National Journal .

The famous Paradox of Thrift holds now more than ever: what is good for the individual, and for the economy in the long run — high saving — is bad for the economy in the short run.  During the current worst-post-30s recession we need a boost to demand.   In the longer run we need more saving.

Americans could not have gotten the timing worse. During the three expansions of 1983-2007 the economy grew well, and by the end of the period the first baby boomers had reached their peak earning years. Yet households’ saving rates declined, falling almost to zero in 2005-07.  Meanwhile, the government ran record deficits, reducing national saving even more (in the 1980s and 2000s; the late 1990s saw surpluses). It is ironic that the pro-capital orientation to the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 was largely sold as an incentive to increase saving and investment, and yet household saving fell sharply subsequent to both policy changes — to say nothing of national saving. The increase in the after-tax return to saving did not lead to a “return to saving.”

The saving rate was so low before the financial crisis that it had nowhere to go but up, even if the timing has been awful. Incidentally, that the first substantial increase in American saving rates in 30 years has come in response to the worst recession in 70 years should put a nail in the coffin of macroeconomists’ practice of lavishing attention in their models on the mathematics of intertemporal optimization.   (But it probably won’t.)

Presumably the magnitude of the current economic dislocation is teaching many blind-sided individuals the value of precautionary saving. We certainly will need further increases in saving as soon as the recession is over. But have we seen a major permanent change in Americans’ anti-saving culture? I fear not. Even now, it does not occur to people that it is desirable to pay cash for auto purchases or other consumer durables, or eventually to pay off their mortgage when possible. Even now, it does not occur to politicians to change the pro-housing bias in the tax law, by eliminating the tax-deductibility of mortgage interest for example.

Moreover, the very first baby-boomers have now started to retire. Increasingly, the higher saving rate of those who see retirement looming ahead (some of whom now “have religion”) will be counteracted by the dis-saving of those who do retire.

The same thing will probably happen in other countries.  Indeed, in Japan, which reached the retirement bulge first, the saving rate fell correspondingly. Europe and China will probably follow. I declare the end of the “global savings glut.”  Real interest rates will have to rise.

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