April 10, 2005

Volcker Sounds a Muted Trumpet

OK, so this isn't new news either. Paul Volcker gave the speech from which this Washington Post column was adapted two months ago. His warning about the economic thin ice upon which we are skating was seconded last week by the World Bank's Global Development Finance 2005 report about which
Dan Drezner has a good collection of links.

So the imbalance, or disequilibrium, or whatever one wants to call the circumstance of America's massive surplus of consumption over savings is not a new subject in the blogosphere, which for better or worse can only talk about it. Can Congress, the Bush administration and the Federal Reserve do much more?

Here Volcker is annoyingly unhelpful. "...[T}he United States, by some combination of measures, should forcibly increase its rate of internal saving, thereby reducing its import demand." What is that supposed to mean, exactly?

Pretty obviously it means higher interest rates imposed by the Fed. What else? Volcker doesn't say. Perhaps by "some combination of measures" he means an interest rate increase now combined with more interest rate increases later, which is a plausible strategy. Interest rates increasing into the indefinite future could encourage individual saving (as of February, this stood at an average of 0.6% of income) and reduce imports through reductions in overall demand -- in other words, through a recession. Some portion of the increase in saving would be offset by the increased cost of borrowed money to the federal government -- with an FY 2004 deficit estimated at $412 billion and more monster deficits expected to follow, this increased cost could be substantial.

Congress and the administration could address that issue by addressing the federal budget deficit, and I wish that Volcker -- who has no voters to face and credibility that other commentators lack -- had spelled out ways to do this. Pretty clearly these boil down to tax increases and spending cuts, but in both cases some are better than others. Just as one example, imposing new tariffs on imports from China and Japan could reduce America's trade deficit with those countries quickly while raising substantial revenue. It would also mark a 180 degree reversal of decades of American trade policy and encourage protectionism is countries around the world. It's a terrible idea.

But it will be considered in Congress, and considered seriously along with other terrible ideas if better ones are not advocated in detail now.

Posted by Joseph Britt at April 10, 2005 04:57 PM | TrackBack (1)

Hmmm. But the fact that he put it out there speaks volumes. I'm not aware that this is common ex-Fed Chief behavior.

Posted by: praktike at April 11, 2005 04:34 PM

What is that supposed to mean, exactly?

Why is this hard? It means fiscal tightening, supplemented if possible by incentives for private sector saving (such as private retirement accounts as add ons not carve outs).

Raising interest rates is self defeating. Higher interest rates -> currency appreciation -> higher current account deficit.

Posted by: Robert McDougall at April 11, 2005 05:56 PM

A good take on this mess is here.....worth reading:


Posted by: cosrtr at April 11, 2005 06:14 PM

Please do not confuse monetary policy with fiscal policy, and budget deficits with current account deficits.

Does the US have a low household savings rate? Yes. It has always had a low household savings rate by international standards, and it is even lower now.

The Fed has been raising interest rates steadily to increase savings and reduce consumption. Every expects the Fed to continue raising interest rates steadily to increase savings and reduce consumption.

Is the government running deficits? Yes, there are budget deficits, but in all honesty the budget was indeficit even during the Clinton years if the Social Security and Medicare unfunded liability were taken into account.

So, if rates are rising and the government is running deficits, why are long term interest rates so low? People think this is because Asian banks are being irrational, or maybe it's because the deficit is not as bad as people think, and rates will not rise too much more.

But the point is that low interest rates now mean that the US does not need to be fiscally conservative. In fact, you could argue that not taking cheap money when it was being offered would be the fiscally imprudent thing to do.

When interest rates rise, which they must, then will be the time to scale back spending. But to not take advantage of cheap money when it's on offer is wasteful.

Posted by: w at April 11, 2005 07:20 PM

There are other ways to increase savings beyond interest rates. Privatization of Social Security may or may not help, depending on who you talk to. Reducing taxes on capital gains and dividends might help a little. A national sales tax is another possibility, albeit less likely. Encouraging companies to default employees to contribute to 401(k) plans unless they opt out would probably make a huge difference, as Tyler Cowen blogged a while back.

But I think the best way by far is through education. Some sort of public campaign on the importance of saving and investing would probably yield tremendous benefits, and ditto for a personal-finance course in high school (although that would be more long-term). Just teaching kids how to balance a checkbook (or to use Quicken or whatnot) would work wonders.

Posted by: fling93 at April 12, 2005 01:51 AM

Hi all,

Atached is a link to a rather interesting article by Robert Brenner - a leftist Economist. It makes for some interesting reading (if not a little complicated), and makes for some bad news concerning particuarly the US economy - but I think probably speaks for most of the Larger Western Economies. (economically I lean right, but this is interesting nonetheless)

In conjunction with the Oil issues we face, I believe that in the longer term this is a far greater threat to our Western Lifestyles than terrorism is. Oil is fundamental to our economies and it appears that alternative power sources, AND alternative tranportation systems that can utilise alternative power sources are very much in their infancy.

One of the greatest consumers of oil from a carbon fuel source perspective is the airline industry - critical to freight, and of course critical to business. Consider where we are at with electrical vehicles and then consider what we have as an alternative to Jet Fuel and Jet Engines if the oil runs out....


Posted by: Aran Brown at April 12, 2005 02:57 AM

Increasing household savings is by far the most benign of the needed changes. Americans consume a great deal of crap, consume too much of good things (eg 4000 sq ft houses when 2500 sq ft is plenty, 3 cars when 2 will do), and are in the main clueless about the real cost of their children's education and their own retirement.

So there has to be a massive education effort and an equally massive package of sticks and carrots.

Sticks would include federal taxes on junk food, the 2 million or so porn videos rented each day, and a higher gasoline tax, for starters. Perhaps also taxes on cheap consumer goods manufactured in China. If your Toys 'R' Us or Home Depot bill just increased by 10%, then perhaps junior doesn't really need his forty-seventh Action Hero figure and you don't really need to spend another $300 on home remodeling.

Carrots would include a wide variety of new and enlarged tax-advantaged savings mechanisms such as 401k-style savings accounts for education and health care.


Posted by: thibaud at April 12, 2005 05:24 AM

Using interest rates to raise saving is a lousy solution to the current account deficit problem.

1) It's not clear theoretically or empirically how strong the effect of interest rates on saving is, or even which direction it goes. Certainly some households would be motivated to save more, but others would save less -- for example, cash - constrained households facing higher home loan interest payments. The net effect is unknown.

2) This is not a short-run problem. Raising interest rates would not only raise saving but also lower investment, not desirable long term.

3) Higher interest rates would increase the income deficit component of the current account.

4) Reducing the current account deficit implies reducing the trade deficit and this can happen either through recession or through an improvement in competitiveness, in effect, a real depreciation. Recession is not an acceptable long-term solution. Therefore real depreciation of the US dollar is necessary, exactly as Volcker says, implying loose monetary policy. [To maintain internal balance, this implies tighter fiscal policy than would otherwise be necessary (and already, fiscal policy is a good deal looser than it ought to be).]

This is not a puzzle, just standard economics. For its current condition, the United States has a clear prescription: fiscal tightening and monetary loosening. The only puzzle is how the monetary authorities should act when the fiscal authorities refuse to do their part of the job.

High interest rates may be necessary as a temporary measure in a hard landing scenario; fortunately we're -- yet -- discussing that.

Posted by: Robert McDougall at April 12, 2005 03:10 PM

On a strictly personal note, I recently graduated from college with high student debt (because I had no other source of support) and was lucky to be able to negotiate a salary that provides barely enough money live and make minimum payments on my debt.

This was not debt assumed irresponsibly, but was necessary the make an investment in my future.

I find the prospect of higher interest rates (and therefore higher debt service payments) very scary. And there are an awful lot of people in my position.

Posted by: byrd at April 12, 2005 05:31 PM

It's an odd sort of calculation that counts money held in a bank as household savings, but other investments (education, housing) as not savings at all. Housing at some level is savings. And education spending can easily be investment, and thus savings, rather than consumption.

Spending balances consumption. The money borrowed from a bank to start a business was saved by someone else. So long as it was a reasonable loan, with a reasonable chance of success, there's little problem. The budget deficit is a problem. The current account deficit and the low private savings rate are largely functions of the world finding it more profitable to invest their money in the US. If it stops or reverses, yes, that could be a problem. OTOH, it's also what's led to our prosperity. But all that's a reason to keep the US a good place to invest.

Japan has a tremendously high savings rate, which hasn't helped their economy recently. Why? There's no good place to invest the money.

Posted by: John Thacker at April 12, 2005 06:34 PM

Well, the main economic issue in Japan is deflation, and a high savings rate will worsen that, not help.

Posted by: fling93 at April 12, 2005 10:11 PM

W has a good point. When the government is flinging dollars around, what you want is a net to catch dollars, not a savings plan to eke out the dollars you already have.

Setting interest rates low is the Fed's way to tell you they don't need your help providing liquidity to borrowers, they can do just fine without you.

If you expect you'll maintain a nice income stream for the foreseeable future, why not borrow money now and spend it? Later you can pay it back in inflated dollars. And then save your money at high interest rates. But if you save money before the inflation you're just a sucker. Save now, when you can buy stuff cheap? Keep money at low interest rates for later when it will be worth a lot less?

Well, but people need a big cushion for disasters. Only they don't want to really think about that. What should you do now to prepare for the day when you can walk to McDonalds and buy a $50 hamburger? It's hard to even imagine it. Easier to buy a new DVD and watch it to take your mind off reality and speculations.

A lot of our problems would be resolved if china let their currency float, soon. Then we'd have more jobs and more exports, less imports. People would have the opportunity to work hard for less stuff to buy. Is it better to have more jobs and less consumption? I think so. But lots of people who're already employed would disagree with me. If you have a job you don't want to see wages go down and prices go up. It's better for the people who don't have jobs, and it's the patriotic thing to do. But would voters approve?

Could we force china to let their currency float? If we had a whole lot of renminbi we could. But we don't, they have a whole lot of dollars instead. They have the upper hand, and we're stuck. So we don't get the chance to do the workable unpopular thing even if we develop the desire to.

Posted by: J Thomas at April 13, 2005 03:31 PM

I would support a realistic gas tax, higher sin taxes, etc. on their merits, but I think W has it right in his comment above that we are looking the wrong way through the window. Instead of bemoaning the foolish USA taking incredibly cheap loans from these rascally foreigners, why don't we look at the motivations of the lenders to shove the money in our pockets? Japan has not yet fully gotten out from under the bubble that made 300 acres in downtown Tokyo more valuable than California, and China would rather manipulate the currency markets than have to face unemployment challenges to its political system. When those facts change there may be a lot of disruption in the global economy, but blaming the US ahead of time is not really very constructive.

Posted by: wayne at April 16, 2005 10:47 PM

"The man who can keep his head in a crisis when all around him others are losing theirs, has probably figured out who he can blame it on."

Wayne, I agree it isn't very valuable to figure out who to blame it on. The more important questions are how can the US government and US businesses help us out of the mess? And how can we individually limit our losses?

If things go bad I don't see any good way for US citizens to limit losses. Say you invest overseas. The US public might easily decide to blame *you* and tax away 90% of your principal. You and Bill Gates together.

Say you invest in gold. You take an immediate 50% loss, and then when the price of gold goes up the government decides that you're an evil goldbug and makes it illegal again for americans to own gold.

Maybe get a job overseas, paid in euros etc? Good luck.

Meanwhile it isn't obvious to me what the US government can do. It looks like it's out of our hands at this point, we don't have the initiative.

Posted by: J Thomas at April 17, 2005 12:05 AM
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