What economists forgot during the 'me generation'

Posted Tuesday, January 31, 2012 in Analysis

What economists forgot during the 'me generation'

by Gina Hamilton

Not that long ago, economists understood that austerity in a time of recession or depression would do two things, neither good, if you actually want a recovery.

1.  Austerity efforts would keep the great engine of the economy idle.  That is, the middle class would be unable to "spend" their way out of recession, while the very poor -- those who need government support to survive, would be in danger of actually losing their homes, health, or very lives.

2.  Because the middle class would stop spending, businesses would stop making and selling things, people would lose their jobs, and tax revenues would plummet, actually causing debt to increase and interest rates to drop.

This isn't a Keynesian fairy-tale, it's just common sense.  Why?

The middle class and the poor spend the vast majority of all the dollars that come through their hands and checkbooks.  The very wealthy save the majority of their income.  Recovery comes from spending, not saving.  Putting money in circulation means that local economies improve. 

How does this work? The poor spend virtually every dime they have locally.  They may spend it in places that are less likely to keep the downtowns alive ... an important issue, to be sure, but not relevant to the general recovery.  They buy food, clothes, gas, pay rent (to a local landlord), pay electric bills, water bills, child care providers, car insurance, and so forth.  They can't save, even if they really want to, because there is simply nothing left over at the end of the month. 

The middle classes also spend the majority of their income.  They may save a little, but usually in ways that eventually benefit local economies rather than Wall Street.  They put money in an IRA at the credit union; they save for a kid's college education, they invest in the Christmas Club -- all the money will come back to the local economy.  But they generally spend a lot more than they save.  They are the ones who keep the dentist in his office, the chiropractor in her clinic, the local downtown merchants alive. They buy life insurance, homeowner's insurance, put money in health savings accounts that they actually use to pay for prescriptions and eyeglasses once a year. They improve their homes, and assume they'll be living there for many years.  They go to the movies, they play mini-golf, they go bowling. The middle class takes a vacation and keeps other small local economies alive, eating in restaurants, staying in rented cottages, buying souveniers and beach balls.  They may have a snowmobile, or a sailboat, or a travel trailer.  They may buy a new car every five years. They donate small amounts to charities and churches.  At the end of the month, they've paid their bills, they've done a little good, they've saved a little for the future, and they've done something fun and frivolous with the rest.

The very wealthy, on the other hand, spend a small fraction of their income.  A study by Moody's that followed how the wealthy spent their Bush-era tax cut money ... new income so to speak ... demonstrated that beyond paying down debts, something the wealthy had in common with the middle class, by the way, the rich were far more likely to save the new income rather than to spend it in any stimulative way.  They weren't starting businesses with it.  They weren't buying yachts or season tickets to the ballet with it.  They weren't doing home improvement, they weren't even donating large sums to worthy causes.  They were saving the money.

Okay, that's how the rich stay rich, right? But as a large-scale economic theory, giving money to the rich and hoping for the best is possibly not the best choice for the majority. 

Because economic theories that work should benefit the majority, in the end.

Now, economists used to know this stuff, for sure.  It's perplexing why economists who truly do understand this ... they've had the basic courses in college, honestly ... are able to put this out of mind and drink the Friedman koolaid so cheerfully.

But somewhere along the road, they got sidetracked by a seductive new idea ... that giving money to the superwealthy would encourage them to invest it in the their local communities.  They'd buy new homes, and everything that went along with it.  They'd start companies and hire employees.  They'd raise the general economy of the local region by pouring dollars into it.  This was the Milton Friedman school of thought, and though Friedman didn't live long enough to watch it crash and burn, it was the dominant economic theory of the "me generation".  During the same period of time, middle class pensions gave way to 401K programs (if the workers were lucky), wages stagnated, unions were busted with the connivance of the government, and the tax brackets were collapsed, so that the poor and the rich were paying a tax rate that was much closer to one another than ever before.  The middle classes were lulled into a false sense of security by "bubbles" that gave them a temporary economic boost, but bubbles always burst, and usually those in the know ... guess who? ... get out before the collapse, while those left holding the bag are those who can least afford it.  By the late 90s, deregulation had changed the entire financial services landscape, in favor of the superwealthy, leaving those who were "Main Street" rather than "Wall Street" out in the cold. 

The problem is, the new idea didn't work, and the gap between the rich and everyone else grew exponentially.

But let's get back to austerity.

The U.S. has a high debt load; but it's not as high as it has been in years past, including many years when the middle and lower classes were doing pretty well, including the immediate postwar era.  What debt does is increase uncertainty, and uncertainty is something the very well to do have serious concerns about. So far, the high debt hasn't done what high debt usually does ... increase interest rates and increase inflation, for instance.  But to an extent, that's because the very people who could have driven interest rates higher have elected not to do it.  Inflation increases when there are too many dollars chasing too few goods.  Right now, the rich aren't putting their money into those goods, so inflation ... and its little cousin, interest rates ... have remained historically low.  When inflation heats up, the Federal Reserve typically tries to put the brakes on the economy by raising interest rates.  When stagnation occurs, they drop interest rates.  Right now, the interest rates are hovering near zero.

So it actually pays us to go into debt while the interest rates are so low.  We should be borrowing ... and stimulating the economy ... when it costs us so little to do it. Imagine that your family needs a car.  You can buy one now, when interest rates for automobiles are about 5 percent ... or you can buy it later, when the interest rates are going to be very uncertain.  Which should you do? Any householder worth his salt would opt to buy the car, even though it means going into debt, when the interest rate is historically low. Besides, keeping the old car running for another five years is likely to cost more in the long run.

The stimulative effect of borrowing for, say, infrastructure or clean energy programs, will put cash back into local economies around the country.  People who might have otherwise been unemployed are working as members of the middle class, doing all the things the middle class does with its money, which has a stimulative effect on the local economies.

Contrast this with an austerity program for the sole purpose of paying down national debt.  So-called discretionary spending ceases, and no money is pumped into the economy.  The green energy programs and infrastructure programs will be funded, eventually ... but with much more expensive dollars than could be had today.  The problems will be worse and more complicated, and end up costing more, just as keeping the old car will.  At the same time, the poor and middle classes who would have benefitted from the jobs and secondary spending (people who are working at a jobsite buy lunch at diners and coffee at donut shops and work clothes and steel toed boots that they wouldn't otherwise buy) won't realize those benefits.

In short, it's time to relax about debt, and worry more about unemployment.  If we get back to something like full employment, debt will virtually take care of itself -- even government workers pay taxes.

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