Friday July 01, 2022

Problem in economics

September 06, 2021

The release of the new Social Security Trustees Report, coupled with a New York Times article on what strikes me as a rather silly debate on inequality, led me to think again about the lack of self-reflection in economics. We have seen a 180 degree turn in the understanding of one of the most basic economic problems, yet there is almost no one anywhere saying something to the effect of “yeah, we got that wrong, and here’s why.”

I’ll get to the contradiction in a moment, but first I want to explain why I think the debate which was the focus of the Times article is rather silly. The essence of the debate in the Neil Irwin piece (the Times reporter who wrote the article) is over whether inequality is leading to lower interest rates, which generates greater wealth inequality, or whether the big problem is the low interest rates themselves causing wealth inequality.

To my mind, this is a silly debate, starting with the idea that we should be concerned about inequalities in wealth resulting from low interest rates. That one is a bit hard for me to see.

Just to be clear, there is no doubt about the relationship between interest rates and wealth, as traditionally defined. Low interest rates increase the value of assets like houses, stocks, and bonds. In the last case, the relationship is literally definitional. If a very long-term bond pays a $10 a year coupon, it will be worth roughly $250 when the long-term interest rate is 4.0 percent, but $500 when the rate is 2.0 percent. The question is whether we should be bothered when all the rich people see their stocks, bonds, and to a lesser extent homes, double in price when interest rates plunge.

I know this provides a lot of grist for academic papers, and for foundations who are ostensibly concerned about inequality, but I just have a hard time seeing the problem here. Part of the story is that I sort of doubt that any of these people will be celebrating the reduction in inequality if things went the other way – we saw a sudden surge in interest rates and the stock market fell 50 percent (the celebrants weren’t very visible in the 2008-09 crash).

But the bigger problem is that I just see their accounting as giving a very incomplete picture of wealth. For the vast majority of middle-income people, wealth reflects the ability to meet needs they face in their lifetime. They accumulate wealth in order to cover the cost of their retirement, their health care expenses, especially in old age, and their kids’ education. Middle class people rarely accumulate any substantial sums beyond these needs.

If it’s not already evident, these needs are also often met by government-provided social insurance, like Social Security, Medicare, and, in countries other than the United States, publicly supported colleges and universities. In effect, for middle class people, social insurance provides a direct substitute for wealth.

In many cases, this substitution is quite explicit. In a country with a high wage replacement rate for its Social Security program, workers don’t need to accumulate large amounts of wealth in 401(k)s to support themselves in retirement. The same is true if public health care programs can be counted on to pay their health care expenses. And, they don’t need to save for their kids’ college if it’s free or cheap.

We could of course count these benefits as “wealth,” but then the story of low interest rates causing inequality would largely disappear. Middle class workers would see the value of their Social Security and retirement health benefits soar when interest rates plummet, in the same way that bond prices soar. The whole problem of interest rates causing inequality then disappears.

Okay, but I don’t really want to destroy the basis for a major academic debate, just noting why I don’t see the problem. (I also have a hard time seeing it as an inequality problem when tens of millions of middle-income homeowners are able to save thousands of dollars a year on their mortgage, car, and credit card payments. But, that’s just me.) Anyhow, let’s get on to the bigger question.

This really should be a joke, but it is now a central question in economics. The reason why this should be a joke is that the answers give images about the economy that are 180 degrees at odds with each other.

The saving too much story is that we don’t have enough demand in the economy. If our main economic problem is that we save too much, then we help the economy, meaning we will have more growth and employment, if we spend more money.

If we are in this world, we should worry that budget deficits are too small, not too large. We should be very happy to give low and moderate-income families additional money to support their kids and to ensure they have a decent living standard. (We should be happy in any case, but if our problem is that we save too much, then this money doesn’t have to be a trade off against other spending. We aren’t up against any constraint, so there is no reason not to make these payments.)

President Biden’s investment proposal looks especially good in the saving too much story. If the problem is that we don’t have enough spending in the economy, why wouldn’t we make whatever expenditures are necessary to quickly create the infrastructure for a green economy, as well as providing workers and businesses with subsidies to encourage them to quickly shift to electric cars and trucks, and clean energy sources for their homes and businesses.

And of course, we should want to improve the skills of the workforce by supporting free community college for the short-term and pre-K and child care for the longer term.

And, we also should shore up our care-giving economy, with increased support for home health care and other forms of care for seniors and the disabled as well as improving the pay and working conditions for those employed in the sector.

If our economy’s main problem is that we are saving too much, we essentially have a green light to address all sorts of problems that have lingered for decades.

Excerpted: ‘The Which Way is Up Problem in Economics’