Tag Archives: recession

Save Money By Booking Early

The harsh, long winter that many people have faced this year has encouraged millions of travelers to book their summer trips early—people just want to get out and get to some place warm. With an increase in demand for summer travel, it is no wonder that summer travel prices are already on the rise. But besides this desire to escape the cold, could there also be something else behind this pent-up demand? Travelers are tending to travel farther away and stay for a longer duration of time. Could this possibly be caused by pent-up demand still from the recession? As we came out of the recession with a slow recovery, people tended to stay close to home and scale back summer trips.

Evidence for this comes from the Bureau of Labor Statistics, showing that travel expenditures during the period of 2005-2011 actually slowed. In response to the recent recession, expenditures on travel for pleasure declined sharply and still had not yet fully recovered by 2011. In 2008, the first full year of the recession, consumers reported expenditures that were almost 3.5% lower than those reported in 2007. Reported expenditures declined another 9.8% in 2009, the year the recession officially ended. Although expenditures increased modestly in 2010, they were still lower than their 2007 peak. In this period of a financial crisis accompanied by high unemployment, it is no wonder that people cut back on traveling. Now, however, more people may be feeling more financially secure and may be feeling that this is the summer to go.

Given our winter, and as you might expect, beach destinations are finding to be the most popular. Right now, the number one destination worldwide for summer travel on Orbitz is Cancun, Mexico. While this may not seem as a surprise, the summertime is actually usually the slow season in Cancun, due to the really high temperatures and it being hurricane season. A few of the other popular trending destinations have shown to be Hawaii, the Caribbean, and trans-Atlantic trips to Europe. Compared to last year during this time, U.S.-to-Europe bookings for summer trips are up 9%, according to Airlines Reporting Corp.

As the airline industry has consolidated through both mergers and joint ventures, it has resulted in this big increase in trans-Atlantic fares. On the other hand, multiple joint ventures will have 90% market share on flights between the U.S. and Europe, up from 80% last summer, which will take away some price competition.

Seeing that an increased demand for summer travel has led to an increase in prices, the advice that travel companies give in regards about when to buy summer airfare is simply that “earlier is better”. Chief executive of CheapAir.com says, “European airfares have already gone up an average of $100 since mid-January, and as planes fill up, fares go for remaining seats.” On the other hand, with domestic fares being so volatile, simply flying domestically on a Tuesday or Wednesday can yield great savings.

Post-Recession Trend in Household Income

Despite the improving economy since the recession of 2008-2009 and although household income has begun to recover, the median household income in the United States still remains about 6% below the level that it was at when the recession began. As you can see from the graph generated using FRED, since the end of the recession, real household income has declined for nearly all population groups.

FRED

That is, for all but the most highly educated and affluent Americans, incomes have stagnated. In fact, the figures reveal that the income of the median American household today, adjusted for inflation, is no higher than it was for the equivalent household in the late 1980s. At the end of 2007, the real median household income was nearly $54,000. Five years later, in 2012, it was now just over $51,000.

Since the recession ended in 2009, those that have experienced income gains are almost entirely the top percent of earners. Those at the bottom percentage, on the other hand, have been affected by factors such as high rates of unemployment and nonexistent wage growth; thus seeing a decline in their household income. If minimum wage were to increase, this could help out households with lower incomes, especially those that are below the median.

An increase in minimum wages would also lead to an increase in purchasing power for these middle class and lower class households. While a little income inequality could be a good thing, too much income inequality does not allow for the middle class to get anywhere, no matter how hard they work. This can contribute to the slow recovery of the economy in that there is not enough purchasing power in the middle class and thus not enough demand for the goods and services available. So, if productivity rises and wages do not, we have an oversupply and the economy can’t function.

Not only did we see a drop in household income, but the share of people living in poverty hit 15.1%, the highest level since 1993, and a staggering 2.6 million more people moved into poverty, the most since Census began keeping track in 1959. Just think about all the high school graduates who were looking to go straight into the workforce or even college graduates looking for their first full-time job. The poverty level would even be higher if so many 20-30 year olds were not living at home with their parents. “It’s premature to say this is a permanent change, however,” says economist Michael Pakko. “We’re still dealing with a severe recession and a slow recovery.”

Economic History: Panic of 1896

In my blog posts, I have been trying to write multiple type of posts, such as posts on someone’s paper, someone’s article, or the WSJ articles. This time, I wanted to do little bit of research on economic history.

1896panicThe Panic of 1896 is one of the pre-World War I economic contractions that was caused by the gold standard of the late 19th century and declining world price in terms of gold. The panic, according to the NBER business cycles dates, dated from December of 1895 to June of 1897. During the panic, the business activity declined by 25.2% and the unemployment rate increased from 13.7% in 1895 to persisting 14.5 % in 1896 and 1897 following a decrease in unemployment rate from 18.4% in 1894 (Romer, 58). At the beginning of the contraction and the end of brief recovery from the Panic of 1893, the aggregate output of the economy hadn’t reached the peak of the previous business cycle; therefore, the Panic of 1896 is often considered as a continuation of the Panic of 1893. The Panic of 1896 was caused by a huge
drop in the Treasury’s gold reserve because of the public suspicion for departure from gold standard, whereas the Panic of 1893 was caused by bank runs due to concern over the solvency of the banks.

Cause of the Panic

Deflationary period

The panic relates to the US business cycle contraction defined by NBER as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

a-monetary-history-of-the-united-states-1867-1960-chart-8

A slowing of the rate of increase of the world’s stock of gold, an increase in the number of countries on the gold standard and a higher growth rate of the total economic output resulted in a deflationary period from 1875 to 1896 with a rate of 1.7% a year in the US (Friedman, 69). The US money stock increased only 6 percent from 1891 to 1896. In meantime, the nominal net national product decreased by 1 percent per year on average, whereas the real net national product increased by 2 percent per year (Friedman and Schwartz, 97). The rate of growth of the real output, which was greater than that of growth of the money supply during this period, put pressure on nominal price.

Prior to 1873, the US was under bimetallistic standard. The Coinage Act of 1873 essentially demonetized silver by omitting the silver dollar of 371.35 troy grains of pure silver, and the Resumption Act of 1875 further established the gold standard. During this deflationary period, political movements for free silver coin and departure from the gold standard in the
US were increasing as the United States needed an increase in the money stock to stop the deflation. Farmers, being unable to pay their debts with lower prices, and silver producers, who was hit by lower silver price, formed the People’s party and The National Silver party.As the gold reserve in the Treasury dropped to $45 million in January of 1895, the public’s worry for the maintenance of the gold standard, which was proximately originated by the Sherman Silver Purchase Act of 1890, put more pressure on gold reserves.

Election of 1896

William_Jennings_Bryan,_1860-1925

In July of 1986, William Jennings Bryan’s nomination from the Democratic Party for the 1896 presidential election further intensified the pro-silver movement because of his platform for “free silver.” Hoping he would win the election, the People’s party and the National Silver party also nominated him for the election. After his nomination, the demand for foreign exchange increased as the dollar holders wanted to convert their dollar to the currencies that were backed by gold. To do so, dollar holders demanded to convert their dollars to gold first by putting more pressure on gold reserves. In other words, the election accelerated net gold outflows (Friedman and Schwartz, 112).

Another view on the cause of the panic is cotton harvest fluctuations due to exogenous variables, such as weather (Hanes and Rhode). Among the main three crops, wheat, corn and cotton, the cotton production fluctuation was the only one to affect the industrial production of post bellum period (Hanes and Rhode). Way the cotton harvest affected the downturn of the business cycle was through the decrease in the reserves in banks and stock price decline. The poor cotton harvest year in 1896 caused a decrease in cotton export and the decline in gold inflow. The cotton export revenue accounted for 25% of the total merchandise export revenue from 1880-1913 (Hanes and Rhode), so a fluctuation in the cotton harvest was one of the factors that could change the business cycle.

The way out of the panic

To stop the gold outflows, a group of gold-shipping and foreign exchange houses agreed to block the outflows. The group borrowed funds in foreign currencies from abroad and exchanged it with the American investors wanting foreign currency and foreigners holding dollars. By doing so, people transferred their dollars into other currencies without first converting them to the gold; therefore, the decline in gold reserves was managed.

When the harvest time came at the end of the August of 1896, crop
export season started and gold inflow started to increase. The victory of the
Republican Party in the presidential election eased the public’s worry about
the US’s departure from the gold standard.

Politics Driving the Economy

Four years after the kickoff to the great recession the Congress is now working to remove itself from the financial industry, however it seems politics may make the process more painstaking than need be.

A quick recap on the recession. During the early 2000s big banks began righting off sub prime loans for new home purchasers, take greater and greater risks. People that couldn’t afford to pay off the loans were starting to qualify and purchase housing. Fannie Mae and Freddie Mac began purchasing these loans from lenders at cut rates. As they began collecting more and more started started defaulting on their loans, leaving the companies in financial ruin. The problem was the economic disaster that would have ensued had these companies completely failed. Instead of allowing them to go over the government stepped in and bailed them out, and essentially took over the company.

Fast forward four years and the companies seem to have returned around like the economy. Stock prices have rose almost 400% since the collapse and the companies are turning profits. As part of the bailout deal the companies are paying all their profits to the government as dividend payments. Since they started turing profits the companies have paid the government almost $185 Billion and are expected to match that in the next 10 years.

So now that the companies are back on track its time for the government to back out and allow the companies to operate in the free market. The problem is the two parties are stuck on smaller issues that will hold up the bill allowing the separation. On top of the part differences Congress is approaching a midterm election and isn’t likely to rock the boat per se until post election, leaving minimal time to debate.

The new proposal is an overhaul to the system. In the past Fannie Mae and Freddie Mac would have packaged the loans into Mortgage Backed Securities or Corporate Bonds and sell them to investors, with a guarantee to make good. The problem was the companies held little capital which was disastrous as defaults started rolling in. The proposed regulations would force companies that act like Fannie and Freddie to hold large capital assets, and would create a regulator to collect insurance payments for devastating situations, much like the FDIC. The final part would allow the securities to be government backed but not the companies themselves, allowing them less leeway to operate on the borderline they became accustomed to in years past.

The parties seem to be okay with the essential structure. The problem comes in the side work. The democrats are looking for more government funding in affordable housing. And the Republicans aren’t to pleased with the amount of government backed home loans worked into the bill. In my personal opinion the parties should leave the side issues neutral and agree on the essential framework. This would allow Fannie and Freddie to reinvest profits and grow their companies at a faster rate. Further solidifying the economic comeback from the recession of 2009.

An Analysis of ‘How the Economic Machine Works’: Part 4

Hey guys, hope everyone’s exams went well. I concluded my last post with a rather dramatic graph of the U.S. debt to GDP ratio from 1916 to 2012. Although it does not completely justify Ray Dalio’s economic model, it does provide some solid proof for the existence of the long-term debt cycle (LTDC)– the third and final pillar of Dalio’s model. This blog post will continue the discussion about the long-term debt cycle. I will try to do touch on a couple of points in this post: (1) reiterate what causes a depression, (2) clarify the difference between a depression and a recession, (3) summarize what a government can do to recover from a depression, and (4) briefly discuss the last part of the LTDC– the reflationary period.

1. What Causes a Depression?

I answered this question in the last blog post, but I got a question about it yesterday, so I thought I’d restate the explanation in a more clear, concise manner: According to Dalio’s model, an economic depression is the second part of the long term debt cycle and it occurs after a long (~50 year) leveraging period. A depression begins precisely at the moment when lenders realize that the debt repayments on the loans they gave out are growing faster than borrowers’ incomes. As soon as the debt growth rate overtakes the income growth rate, borrowers lose creditworthiness. Lenders refuse to lend (aka credit disappears) à spending decreases à people’s incomes decrease à people sell assets to compensate à flood of asset supply makes assets lose value à people’s wealth decreases à lenders refuse to lend even more…and the vicious cycle repeats.

2. What Is The Difference Between a Depression and a Recession?

Technically this is a matter of how you define each term, but the way Dalio distinguishes the two concepts is that a depression is a long-term phenomenon that happens once every 60-80 years (once every LTDC), and a recession is a short-term occurrence, happening once ever 5-8 years (once every STDC).

The economy experiences many smaller recessions throughout the ~50 years prior to the large scale depression, but these recessions can be curbed by the Fed lowering interest rates and stimulating spending. The key difference between the less menacing STDC recessions and the LTDC depression is that unlike a recession, a depression cannot be tamed by lowering nominal interest rates. Why? Because interest rates are already low when a depression begins. In this situation the Fed faces the problem we discuss so much in class: the zero lower bound on nominal interest rates. Even if the Fed is able to decrease interest rates slightly, the change is not enough to extinguish borrowers’ large debt burdens.

3. What Can A Government Do To Recover From A Depression?

The government’s role in a depression is a tricky one. It requires an extremely careful balance between the use of four key strategies: (1) Cutting Spending, (2) Reducing Debt, (3) Redistributing Wealth, and (4) Printing Money.

Cutting spending is necessary in order reduce the government’s debt burden in the long run, but there’s a problem with this strategy: after government spending decreases, the public debt burden gets worse initially. In the short term, a spending cut causes incomes to decrease, prices to drop, and unemployment to rise. Accordingly, the government must be careful not to cut too much spending in the beginning of a recovery because it may push the economy into an even deeper hole.

Reducing debt essentially involves the organization and facilitation of debt default and debt restructuring programs. Most of the time banks handle this, but government can play a role in incentivizing them to do so. During a depression, there are inevitably lots of borrowers who cannot pay back their debts. However, since banks would much rather get at least some of the repayment back than none, they agree to restructure certain loans in order to make them more manageable for the borrower to pay off. However, much like cutting spending, reducing debt also increases the public debt burden initially because people’s incomes decrease as a result of paying back the restructured loans. Even lower incomes = even less spending.

Redistributing wealth is a necessary tactic to encourage low and middle-income citizens (aka the majority of a country’s population) to find jobs and start spending money on goods and services again. Governments start running deficits to increase spending on stimulus and unemployment benefits. Furthermore, the government raises taxes on the rich in order to at least partially fund the stimulus programs. It must be careful not to tax too dramatically though. Not only can social tensions escalate quickly as a result of heavy taxation, but also incomes drop. And as we know very well by now, lower incomes = less spending.

The final strategy typically used in depression recoveries is printing money and buying assets. The central bank prints money, and then uses the money to buy financial assets and government bonds. It buys existing assets and bonds from the public, and also buys newly issued bonds from the government. In turn, the government uses the money it got from selling newly issued bonds to fund its fiscal stimulus, raising incomes and eventually pushing the public debt burden down. Again though, the government must be careful when printing money/buying assets because buying up financial assets drives up their price (inflation) and increases the government debt burden.

Phew. That’s a lot to digest for one blog post but the main idea is this: In a depression recovery the government must strike a keen balance between strategies that cause deflationary pressures (cutting spending, debt reduction, wealth redistribution) and strategies that cause inflationary pressures (printing money + buying assets). If the balance between these pressures is struck correctly, the recovery pulls the economy out of depression and the last phase of the LTDC begins: the reflationary period. Growth is slow initially, but incomes increase, credit becomes available again, and debt burdens finally begin to fall.

An Analysis of ‘How the Economic Machine Works’: Part 3

In my last blog post, I discussed the short-term debt cycle and began to talk about the long-term debt cycle. This is the third post in the set and will focus on the long-term debt cycle and will begin to look at some of the data backing up Dalio’s claims.  In the short-term debt cycle (STDC) spending is restricted only by the willingness of lenders and borrowers to provide and receive credit, but as was discussed at the end of the last blog post, the STDC doesn’t give us a full picture of what’s going on. The long-term debt cycle gives us a broader view of what is happening.

3. The Long-Term Debt Cycle (LTDC) (60-80 years)

The LTDC is the final of the three factors that Dalio asserts drives the economy. The LTDC has three parts: (i) leveraging (50+ years), (ii) depression (2-3 years), and (iii) reflation (7-10 years). The main idea is that over the course of about 60 to 80 years, the economy undergoes a large cycle, starting with a period of above-average productivity growth (leveraging), which eventually falls dramatically (depression), and then starts growing again (reflation). Let’s take a closer look at each part separately.

The leveraging period has been discussed throughout my past two blog posts and is directly tied to the idea that credit allows people to increase income growth beyond productivity growth in the short run. During the leveraging period, the economy is undergoing short term debt cycles of expansions and recessions, but each cycle’s bottom and top finishes with more income per person and more debt per person than the last one. At first, incomes increase faster than debts do, and as long as borrowers’ incomes rise faster than their debts, they remain creditworthy. This is what is known as ‘a bubble’; with asset values and incomes growing quickly, lenders are still willing to lend even though the public debt burden is increasing. Goods, services, and financial assets are all being bought with borrowed money. At some point, however, this false paradise must end. The bubble pops at precisely the moment when debt repayments start growing faster than incomes. Queue the depression.

In a depression, the large debt repayments cause incomes to fall dramatically. Many borrowers can no longer afford to pay back their debts with income, so they resort to selling assets. Since many borrowers are selling assets at once, the market is flooded with supply causing asset prices plummet. Plummeting asset prices mean that the value of borrowers’ collateral drops as well, making them even less creditworthy. Incomes drop, credit disappears, asset prices fall, and borrowers can’t repay their debts, making for a self-perpetuating disaster. It’s the same negative feedback loop I talked about in the last blog post, except in epic proportions.

Take a look at the following graph that illustrates the U.S. debt to GDP ratio from 1916 to 2012. Notice that the debt/GDP ratio increased steadily before both 1929 and 2008, spiked upward right after, and then falls dramatically:

U.S. Debt to GDP Ratio

This graph is not a full justification of Dalio’s claims, but it does illustrate a certain cyclical nature in the debt/GDP ratio, which gives credence to the LTDC. It’s pretty clear that after the Great Depression was over by the mid 1940’s, debts began to grow steadily until 2008. That’s about 50 years and resembles the characteristics of the leveraging period of the LTDC I discussed earlier.

In the next blog post I will take a closer look at the strategies government use to deal with large-scale recessions and further explain the reflation period of the LTDC.

An Analysis of ‘How the Economic Machine Works’: Part 2

As I mentioned in the last blog post, this is the second post of a new set of blog posts I’m writing about credit and its effect on the U.S. economy. In this post, I will discuss the second key driver of the economy according to Ray Dalio’s model: the short term debt cycle.

I ended the last blog post with a preliminary discussion of what credit is and why it causes economic swings. As we saw, credit allows people to increase income growth beyond productivity growth in the short run. It allows us to consume more than we produce when obtained, and forces us to consume less than we produce when we have to pay it back.

2.    The Short Term Debt Cycle (STDC) (5-8 years)

The second factor that Dalio asserts drives the economy is the short-term debt cycle. The STDC has two parts: (i) expansion and (ii) deflation/recession and these parts’ duration and severity are chiefly controlled by the central bank.

In an expansion spending increases due to increased credit availability (see my previous blog post for a detailed explanation of why this happens) and this in turn causes prices to increase (aka inflation).  The reason prices increase is not immediately obvious. Dalio asserts that, on a macro level, prices are just spending divided by quantity of goods sold. Since spending = amount of credit spent + amount of money spent, when credit availability increases, spending increases faster than the production of goods, and thus prices increase. If prices begin to rise too much, the central bank steps in and uses one of its main monetary policy tools: manipulation of interest rates through open market operations. Seeing the growth in inflation, the central bank will raise interest rates in order to slow down borrowing and stabilize prices.

In a deflation spending decreases due to decreased credit availability, causing prices to decrease (aka deflation). A higher interest rate means less people will borrow money and existing debt payments increase. This causes spending to slow, causing incomes to drop, causing lenders to be less willing to lend, causing less credit to be available, causing spending to slow…and the cycle continues. This is the opposite of the cycle I discussed in the last blog post. It’s a negative feedback loop. And if this drop in economic activity is severe enough, it leads to a recession. Most of the time, though, the central bank is able to halt the drop in prices by decreasing interest rates, stimulating spending, and causing another expansion.

That’s it. That’s the short-term debt cycle. Each cycle lasts about 5 to 8 years and it continues for decades. When credit is available, there’s an expansion. When it’s not, there’s a recession. And as I said in the beginning, credit availability is affected mostly by the central bank’s manipulation of interest rates. From first glance this seems like the end of the story: the central bank keeps moving interest rates up and down as needed in order to stabilize prices and allow for long term productivity growth. Unfortunately, it’s not quite that simple. The complication stems from the fact that the bottom and top of each short-term debt cycle finishes with higher productivity than the previous one (no problem so far) but also with more debt (there’s our problem). The main difficulty is that at some point, after decades of short-term debt cycles, debts begin to rise faster than productivity. This also means that debts begin to rise faster than incomes. Uh oh. This is where an explanation of the long-term debt cycle is in order. Stay tuned for the next blog post. Will be up shortly.

Is the U.S. soon to recover from the recession?

In recent news, the United States economy has been showing overall signs of improvement. There are still  factors that could possibly lead the economy into regression, but many economists predict the economy to be advancing quickly. The root to success has been a rise in exports, consumer spending, and business investment.

Furthermore, GDP has grown at a seasonally adjusted annual rate of 3.2% in the fourth quarter. This rate is less than the third quarter’s rate of 4.1%, but overall the final six months of the year yielded the strongest since 2003, when the economy was thriving.

The potential risk for the U.S. economy relates to the currency crises in emerging markets, disappointing numbers on jobs, and housing has also declined. Four years after the recession ended, this rebound has been weak compared to past recoveries. In regards to the housing market, an index measuring contracts to buy existing homes fell by 8.7% in December. Some economists blame the decline in sales on the unusually cold winter weather, others question whether or not the decline will only be temporary. Most agree that one significant factor of the decline in housing sales roots back to rising interest rates and housing prices.

On the other hand, many economists believe that the Federal Reserve’s recent taper was meant to grow the underlying strength of the economy. Consumer confidence has risen and manufacturers are busier because of increased demand. Consumer spending is pivotal because it accounts for roughly two-thirds of economic activity. Consumer spending has grown by 3.3%, which is the fastest pace in three years. Also, more U.S. business have been making longer-term investments after years of delaying such spending. Bill Simon, chief executive of Wal-Mart commented, “I never cease to be amazed at the American consumer… They figure out ways to make it work. Long term, I’m very optimistic”.

In my opinion, I also have optimism for the full recovery of the U.S. economy but I have my doubts as well. Recently, domestic investment in real estate has fallen and also the turmoil in emerging economies is yet to unfold. If the outcome of this situation did not favor the United States, our exports would take a hit. If investors anticipate the changes in international markets to be unfavorable, this would also affect Americans’ investment portfolios. This in turn would leave less room for consumers’ discretionary purchases. For these reasons, I believe that the outcome of the emerging market economies will play a crucial role in determining the future recovery of the U.S. economy.

(Revised) Rising Inequality Explains the Weak Recovery, Not Vice Versa

In this article, I will not passionately try to convince you of the post title. Instead, I will make points on how John B. Taylor’s argument on the topic fails under more scrutiny. In his article in the Wall Street Journal, titled “The Weak Recovery Explains Rising Inequality, Not Vice Versa”, John B. Taylor makes following use of data to make his point that today’s inequality isn’t a cause of the type of recovery we are witnessing. First, he explains what the people who he is arguing against say: the slow recovery has been a result of growing inequality. He writes down their argument as follows:

“The key causal factor of the middle-out view is that a wider income distribution slows economic growth by lowering consumption demand. Saving rates rise and consumption falls if the share of income shifts toward the top, according to middle-out reasoning, because people with higher incomes tend to save more than those with lower incomes.”

And then he goes on to counteract this view by data he collected and put some make up on. He gives what his data shows:

“The data for the recovery since mid-2009 do not support this view. The 5.4% overall savings rate during this recovery is not high compared with the 8.4% average since 1960. It is relatively low compared to past recoveries, such as the 9.3% savings rate during a comparable period during the recovery in the early 1980s.”

In my curiosity, I was able to look at the data he worked on. It is data on personal saving ratio-the ratio of personal saving to disposable personal income. The following graph shows what the saving rate has been.
PSAVERT_Max_630_378John Taylor is correct on that the saving rate has been averaging 5.4% since the end of the latest recession. However, when he tried to compare this rate to the 8.4% average rate since the 1960, he makes wrong comparison. Due to the general downward trend of this rate over the last decades, he shouldn’t compare this 5.4% average rate of saving during the recovery to the all time average saving rate. But if we compare the 5.4% average rate during the recovery with the average saving rate between the end of 2001 and the start of the recession, which is 3.9%, we can see that the saving rate today is higher than its pre-recession level. Therefore, we have just disproved his claim by using the same argument he tried to use. In other words, with data on how the income inequality has grown, we have further see that the saving rate also increased after the recession.

10economix-sub-wealth-blog480Hence, we are able to claim that the increase in inequality indeed increased the saving rate; therefore, the total consumption demand has declined, which is exactly what the people he argued against said.

One could argue that increased personal saving rate isn’t caused by the increasing inequality . It is possible that because people might be willing to save more than what it was saving before the crisis to use their saving when another crisis comes during the recovery and uncertainty. Therefore, one could say inequality isn’t playing a much role in hindering a recovery today.

However, this surge in the saving rate after any given recession has been witnessed only twice, once after 2001 and again after 2007-2009 recessions.  The prior recoveries experienced the saving rate which was actually lower than its level before the crises. If we look at the average saving rate between November 1970 and November 1973, it was 12.8% which is higher than the saving rate after the recession, between April 1975 to December 1979, which is 10.8%. The same decrease in the saving rate was seen also during the early 1980’s recovery. We can see this trend of decrease in the saving rate following any recession in the above graph except for the last two recoveries. In last two recoveries, the saving rate surged and stayed at the higher level than it was before the recessions.

In my very first blog post, I compared the income inequality during the pre-recession periods for the Great Depression and the Great Recession and argued the recovery the economy is going through now is unhealthy one. One could agree with John Taylor on that the weak recovery is causing the widening inequality and the first problem policymakers should tackle is to boost the recovery by any means. However, the increasing inequality could be the heart of the problem, and the policymakers should prioritize equality to change the speed of the recovery. But how the inequality must be tackled should be devoted to a number of blog posts itself. I believe recent discussions and steps toward solving the inequality is a way to fasten the recovery.

Rising Inequality Explains the Weak Recovery, Not Vice Versa

In this article, I will not passionately try to convince you of the post title. Instead, I will make points on how John B. Taylor’s argument on the topic fails under more scrutiny. In his article in the Wall Street Journal, titled “The Weak Recovery Explains Rising Inequality, Not Vice Versa”, John B. Taylor makes following use of data to make his point that today’s inequality isn’t a cause of the type of recovery we are witnessing. First, he explains what the people who he is arguing against say: the slow recovery has been a result of growing inequality. He writes down their argument as follows:

“The key causal factor of the middle-out view is that a wider income distribution slows economic growth by lowering consumption demand. Saving rates rise and consumption falls if the share of income shifts toward the top, according to middle-out reasoning, because people with higher incomes tend to save more than those with lower incomes.”

And then he goes on to counteract this view by data he collected and put some make up on. He gives what his data shows:

“The data for the recovery since mid-2009 do not support this view. The 5.4% overall savings rate during this recovery is not high compared with the 8.4% average since 1960. It is relatively low compared to past recoveries, such as the 9.3% savings rate during a comparable period during the recovery in the early 1980s.”

In my curiosity, I was able to look at the data he worked on. It is data on personal saving ratio-the ratio of personal saving to disposable personal income. The following graph shows what the saving rate has been.
PSAVERT_Max_630_378 John Taylor is correct on that the saving rate has been averaging 5.4% since the end of the latest recession. However, when he tried to compare this rate to the 8.4% average rate since the 1960, he makes wrong comparison. Due to the general downward trend of this rate over the last decades, he shouldn’t compare this 5.4% average rate of saving during the recovery to the all time average saving rate. But if we compare the 5.4% average rate during the recovery with the average saving rate between the end of 2001 and the start of the recession, which is 3.9%, we can see that the saving rate today is higher than its pre-recession level. Therefore, we have just disproved his claim by using the same argument he tried to use. In other words, with data on how the income inequality has grown, we have further see that the saving rate also increased after the recession.

10economix-sub-wealth-blog480Hence, we are able to claim that the increase in inequality indeed increased the saving rate; therefore, the total consumption demand has declined, which is exactly what the people he argued against said.

One could argue that  because people might be willing to save more than what it was saving before the crisis to use their saving when another crisis comes during the recovery and uncertainty, the higher saving rate doesn’t say that inequality is hindering the recovery. But this surge in the saving rate after a recession has been witnessed only twice, after 2001 and 2007-2009 recessions. Prior recoveries experienced the saving rate which was actually lower than its level before the crises. If we look at the average saving rate between November 1970 and November 1973, it was 12.8% which is higher than the saving rate after the recession, between April 1975 to December 1979, which is 10.8%. The same decrease in the saving rate was seen also during the early 1980’s recovery. We can see this trend of decrease in the saving rate following the recession in the above graph except during the latest two recoveries.

In my very first blog post, I compared the income inequality during the pre-recession periods for the Great Depression and the Great Recession and argued the recovery the economy is going through is unhealthy one. One could agree with John Taylor on that the weak recovery is causing the widening inequality and the first problem policymakers should tackle is to boost the recovery by any means. However, the increasing inequality could be the heart of the problem, and the policymakers should prioritize equality to change the speed of the recovery.