Ok, first the Op-Ed by the NY Times resident (or heads) socialist, then a response..
First the Op-Ed:
The long-feared capitulation of American consumers has arrived. According to Thursday’s G.D.P. report, real consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent.
To appreciate the significance of these numbers, you need to know that American consumers almost never cut spending. Consumer demand kept rising right through the 2001 recession; the last time it fell even for a single quarter was in 1991, and there hasn’t been a decline this steep since 1980, when the economy was suffering from a severe recession combined with double-digit inflation.
Also, these numbers are from the third quarter — the months of July, August, and September. So these data are basically telling us what happened before confidence collapsed after the fall of Lehman Brothers in mid-September, not to mention before the Dow plunged below 10,000. Nor do the data show the full effects of the sharp cutback in the availability of consumer credit, which is still under way.
So this looks like the beginning of a very big change in consumer behavior. And it couldn’t have come at a worse time.
It’s true that American consumers have long been living beyond their means. In the mid-1980s Americans saved about 10 percent of their income. Lately, however, the savings rate has generally been below 2 percent — sometimes it has even been negative — and consumer debt has risen to 98 percent of G.D.P., twice its level a quarter-century ago.
Some economists told us not to worry because Americans were offsetting their growing debt with the ever-rising values of their homes and stock portfolios. Somehow, though, we’re not hearing that argument much lately.
Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. One is tempted to echo St. Augustine’s plea: “Grant me chastity and continence, but not yet.” For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap — a situation in which the Federal Reserve has lost its grip on the economy.
Some background: one of the high points of the semester, if you’re a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.
In fact, consumers’ income may actually fall more than their spending, so that their attempt to save more backfires — a possibility known as the paradox of thrift.
At this point, however, the instructor hastens to explain that virtue isn’t really vice: in practice, if consumers were to cut back, the Fed would respond by slashing interest rates, which would help the economy avoid recession and lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can’t offset the fall in consumer spending.
I’ll bet you can guess what’s coming next.
For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It’s true that Ben Bernanke hasn’t yet reduced interest rates all the way to zero, as the Japanese did in the 1990s. But it’s hard to believe that cutting the federal funds rate from 1 percent to nothing would have much positive effect on the economy. In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away, yet mortgage rates and the interest rates many businesses pay are higher than they were early this year.
The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.
The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off.
No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.
Where to start. First the gov’t spending argument. How does gov’t get the money Mr. Krugman wants to so merrily spend? Right, from either us or our employers. In the article he claims to reduction in consumer spending is the cause of the current condition we are in. He even goes as far as to say that further reductions in it will cause even more pain as it further will reduce economic activity.
So, how then will the gov’t get this money to spend? Increased taxes. But wait, Paul. Didn’t you just say that us consumers need to spend more in order to avoid further economic deterioration? How will taking more of our money in taxes accomplish that? What about our employers? How will taxing them at a higher rate cause them to hire more of us so we can then spend more?
Do you have a plan for the gov’t to go to Sears (SHLD) to buy washers and dryers or Wal-Mart (WMT) for cleaning supplies?
Now, we all know that 2/3 of all economic activity involves you and me spending the money our employers pay us (or we make ourselves). If one wants to stimulate the economy, doesn’t it make common sense to stimulate the largest portion of it?
Why would we want to stimulate the largest, slowest and most inefficient portion of the economy? If we want the largest effect from any effort, it doesn’t seem like increasing taxes or increasing the deficit is the best way to go.
The problem here is that there is no easy, quick fix. If that is true, then let’s do what we know works.
Capital gains taxes. The only tax action I am aware of that has a 100% effect is the lowering or increasing of the capital gains tax. Lowering it has always lead to increased tax revenue (more profits) and raising them has always lead to a decrease (lower profits). Even those sitting on large losses in stocks this year only get to write off $3k of those losses against gains. The result of this is that if an investor who had a $10k gain earlier in the year but has lost $20k in the last couple months can only write off $3k against income, meaning $7k in income will still be taxed even though there was a loss in excess of it.
Let losses be losses and gains be gains…
Raise the write-off limit to $10k or more and let them lower their taxable income, increase the returns they get next spring. Lower the tax rate on them from 15% to 5% (and have both candidates ensure it stays there) and stop the slide in stocks that is happening as investors fear it will almost double next year.
Lower it and money floods back into stocks, raising values, 401K balances, IRA balances etc. A consumer that sees their retirement savings increasing will be less prone to hoard more money for it and far more prone to spend it.
Gov’t cannot spend us out of this. Gov’t spending in inherently wasteful and inefficient and comes at a cost to other, more efficient forms.
Do I agree that more stimulus checks are a waste? Yes. Gov’t needs to just stop….stop. This problem was years in the making and cannot, no matter what is attempted be solved quickly….it just can’t.
Now, Krugman does not specifically say a tax increase is needed. He is smart enough to stop short of saying that. But, if anyone can find me an example of when he embraced tax cuts, lets me know because I have not seen it.
Just my two cents…….
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