Standards of evidence

In a broadly excellent discussion of theories relating inequality and growth, Jared Bernstein writes:

all of this research is relatively new, and while it makes suggestive connections, there is not enough concrete proof to lead objective observers to unequivocally conclude that inequality has held back growth.

Bernstein absolutely right, of course. But really? “concrete proof to lead objective observers to unequivocally conclude” Is that a remotely meaningful standard of evidence for, well, anything?

People on the political right, including many respected economists, make strong claims that ceteris paribus taxation is bad for growth. They certainly have plausible models in which it would be. But as an empirical matter, the fair thing to write would be there is not enough concrete proof to lead objective observers to unequivocally conclude that taxation has held back growth. The evidence is very conflictatory! To steal Bernstein’s apt metaphor, there are a lot of moving parts! It is in fact almost certainly false to claim that taxation is always and everywhere bad for growth, and almost certainly true that there are circumstances under which it has been and would be good. If you are behaving as a scientist, it’s kind of a shitty, stupid question, “how does XXX affect growth?” How does molybdenum affect life? They are related! But if you start running regressions of liveliness against concentrations of molybdenum, you won’t get very far. If you want to study the relationship between molybdenum and life, or XXX and growth, for any XXX, you’ll have to characterize mechanisms and offer detailed, contingent accounts. You won’t find simple, black box relationships.

But we are not always, or even usually, behaving as scientists. The Tax Foundation will tell you right off that taxes are bad for growth, much worse than spending cuts. Studies prove it, and if you disagree you are simply wrong. Steve Roth aptly wonders why so few voices among “respectable progressives” are willing to even give fair consideration to the case that inequality might be an impediment to growth. I think he has a point. This isn’t a general phenomenon. It’s not like “liberals are cautious scientists, while conservatives run roughshod over the truth”. Progressive economists are willing to assert, in the same stentorian, authority-of-science voice as the Tax Foundation people, that fiscal multipliers are real or that evidence against expansionary austerity is incontrovertible. But on connections between inequality and the macroeconomy, it feels like respectable progressives are always looking for an excuse to say there’s no there there. People who are usually very smart make very thin arguments that are frankly beneath them to cast doubt on the relationship.

Now let’s be perfectly clear: there is no reliable quantitative relationship between inequality and growth, just as there is no reliable quantitative relationship between taxation and growth, between government spending and growth, monetary policy and growth, or pretty much anything else and growth. There are studies, which pare and tease their panels in ways they justify on some grounds or other, and those studies yield conclusions. You can buy the assumptions, methodologies, and mechanisms implicit in those parsings or not, it’s your choice. But you won’t find a clear, incontrovertible relationship between any simple thing and developed world, per-capita growth. It’s too complicated a phenomenon. You have to buy someone’s stories, and interpret the numbers through those stories, to claim the evidence is strong.

But that doesn’t mean there is nothing at all that we can say about inequality and the macroeconomy. We can, for example, say that marginal propensity to consume effects are real. The intellectual history of MPC goes something like this:

  1. There is and has always been an obvious, intuitive, and robust stylized fact that people with higher incomes save greater fractions of their incomes than people with lower incomes. In the post-Great-Depression intellectual climate, which was acutely sensitive to the dangers of demand shortfalls, this suggested, uncomfortably to some, that inequality could be a macroeconomic hazard.

  2. Milton Friedman pointed out that differing marginal propensities to consume observed in the data might have nothing at all to do with inequality. If people try to smooth consumption over time, then in a stochastically equal society (one in which everyone’s expected incomes are the same, but each individual is subject to random fluctuations in any period), we would observe that individuals who happen to have unusually high incomes in one period save a lot, to cover the periods where they will have unusually low incomes. Friedman’s elegant Permanent Income Hypothesis suggested people just spend a constant fraction of their lifetime incomes in every period, so (under perfect information about that “permanent” income) each individual’s spending would be constant and apparently different marginal propensities to consume would be due solely to fluctuations in income, with no actual changes in spending.

  3. For reasons that would be baffling, if I weren’t so cynical about the economics profession, the Permanent Income Hypothesis was generally accepted as sufficient explanation of observed MPC effects in cross-sectional data, and the issue was considered closed. You were naive and ill-informed if you thought MPC effects in the data had anything to do with inequality. They had been explained.

Of course, you had to be an idiot to believe that the Permanent Income Hypothesis fully accounted for MPC effects. Undoubtedly consumption smoothing explains a part of cross-sectional variation in marginal propensities to consume, but you don’t need careful empirics to prove that it can’t explain all of them. Why not? Because not consuming leaves a residue, something called savings, which becomes wealth. If across the income spectrum everyone spent and saved in equivalent proportions, we’d expect no cross-sectional variation in terminal wealth as a proportion of lifetime income. But in real life, much of the bottom of the income distribution dies with zero or negative wealth (i.e. they stiff their creditors), while those near the top of the distribution leave large bequests. An intergenerational Permanent Income Hypothesis could only explain this if poorer people expect their kids to be much wealthier then the children of moguls. Which is not so plausible.

If things that are obvious don’t persuade you, if something has to have tables in the back and be peer-reviewed to qualify as “rigorous”, you are a very severely deluded human. Nevertheless, a few courageous researchers have done the work of examining in numerical detail whether the Permanent Income Hypothesis is sufficient to account for variations in spending, and the answer is always no. I’ve cited ‘em before, I’ll cite ‘em again: “Why do the rich save so much?” by Christopher Carroll; “Do the Rich Save More?”, by Karen Dynan, Jonathan Skinner, and Stephen Zeldes. I’m sure if MPC makes a comeback in macroeconomic conversations, someone prestigious will find some way to parse the data differently and explain it all away again. That researcher will surely die rich.

OK. So inequality-related MPC effects are real. But what to they have to do with growth? Nothing at all, in an unconditional sense. I’ll go further than Bernstein. It’s worse than “there is not enough concrete proof to lead objective observers to unequivocally conclude that inequality has held back growth.” There’s little reason at all to think that inequality has held back growth, in the past tense, through an MPC channel. Why not? Because we didn’t observe in the past anything that looked like an intractable insufficiency of aggregate demand! Past-tense, we reconciled inequality with growth. MPC effects suggest that one way to generate more demand would be to broaden the distribution of income. They do not imply that broadening the distribution of income is the only way. The macroeconomic footprint of increasing inequality lies not in growth, but in the interest rates and financial chicanery that were necessary to support that growth. Call it the monetary offset.

Prior to 2008, we found means of supporting aggregate demand despite an almost certain drag imposed by increasing inequality. Those means included a broad mix that included fiscal policy (we ran deficits), unsustainable equity booms, the “democratization of credit” and unsustainable credit booms, and of course straightforward monetary policy. Real interest rates have collapsed since the early 1980s. The reason we might talk about inequality is not because it is mechanically, unconditionally, here-is-the-regression-now-STFU connected with growth. It’s because many of us have decided that other, more “conventional”, demand stimulants have run their course, that repeating them or increasing the dose won’t work, or would have adverse side effects we’d prefer to avoid.

We have a large menu of ways we can try to support demand. We can go the Scott Sumner route, double down on monetary policy. We could do big, old-style fiscal stimulus, have the government give money to those who lobby best without worrying about fairness or income distribution. We could embrace inefficient health care provision and build more university rec centers. We could have the financial sector figure something out again, some means of enabling those who otherwise wouldn’t be able spend to do so. We can find ways of persuading rich people to spend more. We can import demand from elsewhere, like China and Germany. We can try electronic money and negative interest rates. We are, as they say, free to choose.

But the reality of MPC effects means that, along with all those other possibilities, broadening the distribution of income would be expansionary and narrowing that distribution would be contractionary, ceteris paribus. If, like Larry Summers, it pains you that maybe the “natural interest rate” is negative now, the reality of MPC effects means that policy which broadens the distribution of income would help push it positive, and put us back into more comfortable territory. If, like me and Pope Francis, you think that present levels of inequality are horrific for human and communitarian reasons, then among the many macro policies that might support demand, it is rational to tilt towards those more likely to engender a broad distribution. It is quite irrational, as I think some well-meaning economists do, to hold MPC effects to much higher standards of evidence than the mechanisms that justify other interventions, because “economics is not a morality play” and reducing inequality would be the moral thing. Better to err on the side of human welfare rather than reputational purity.

I happen to think that the macroeconomic case for reducing inequality is much stronger than the case I’ve made here. I think the character of growth is badly misshapen when demand is narrowly sourced, that technological stagnation is mostly a distributional problem, that institutional correlates of growth are harmed by increasing inequality. But those are all more speculative claims. You can tell me the “jury is still out” on those. But the jury is not out, it never reasonably has been out, on the reality of distribution-related MPC effects. I’ll disagree, respectfully, if you claim that for supply-side or libertarian reasons we should ignore that reality and prefer other means of supporting demand (or that we should not worry about supporting demand at all). But don’t say “it’s unclear” whether income distribution affects aggregate demand, holding other factors constant. Of course it does.

 
 

123 Responses to “Standards of evidence”

  1. AK writes:

    Well, what do you expect to happen when they accommodate social darwinism in their supposedly “liberal” political ideology? Humble servants of their Master, which in this case /the very american case/ is The Market and The Market signals with money. Who has the money? The “elites”, therefor they are the Master. The Master don’t like taxes -> the servants don’t like taxes.. and so on.. Repulsive story. It will end very badly for pretty much the whole planet. I mean, after decades of shouting “Privatize, privatize, privatize! The tide will rise all boats.” and “Deregulate, deregulate, deregulate! The Market will do it better.” Same brainwashed incompetent randians, playing same stupid game on global level to protect the expropriated actives of their masters.. tell me how else but with mass murder this will end.. Pathetic.

  2. Steve Roth writes:

    Yeah that’s what I meant to say. ;-) Great as usual.

    I would just say that at least in terms of empirical inquiry, marginal propensity to spend out of wealth, as opposed to income, is potentially a more fruitful line of research. Spending out of income is problematic because spending is income. E=I.

    Funny how this is very much a sort of monetarist, velocity, MV=PQ kind of argument. But it involves the very broadest measure of “M” — all financial assets, or even all assets (since all ownership claims are in some sense financial assets). Net worth, wealth, there are various measures that bear examination.

    U.S. spending as a % of assets (examined via various measures) has been declining fitfully but steadily since the 80s. See my recent posts for graphics. That’s a stylized fact that merits some serious attention, IMHO.

  3. I thought you two were talking about something different on twitter. Turns out it’s closely related but not exactly on topic.

    Something which might impact this discussion is this funny idea I ran across on the internet. This guy was claiming capitalists respond to purchasing power adjusted demand! Have you heard of this idea? ;)

    As long as we’re able to support greater levels of credit, or support expanding one of the other two legs of the economy (govt and foreign sector), the economy can overcome the drag imposed by the propensity for people to try to save in a risk free fashion. The distribution of income and wealth doesn’t matter when we can overcome it with stimulus from one of these three sectors.

    Matt Bruening has been going on about how the distribution isn’t ever a “fair” distribution. It’s always decided by our institutional choices. For example, one choice we make today is the different levels of taxation on capital gains and labor. If we add this differing tax rates on capital gains to the fact rich people save more of their income, we end up with huge concentrations of wealth.

    Steve R points out consumption out of wealth has changed dramatically overtime – we’re consuming less of our wealth as we’ve allowed more concentration of wealth. This can’t be good for growth, by math.

    Great post as usual and the interaction of you and Steve is excellent. Liberals are people who don’t know how to take their own side in an argument. Ha!

  4. JKH writes:

    “the Permanent Income Hypothesis was generally accepted as sufficient explanation of observed MPC effects in cross-sectional data, and the issue was considered closed.”

    That seem unbelievably, monumentally, obviously stupid.

    What is this “profession”?

  5. […] for those who still complain that ironclad, irrefutable evidence is lacking, here’s Steve Randy Waldman explaining why you should STFU. Here just the conclusion; read the whole […]

  6. […] for those who still complain that ironclad, irrefutable evidence is lacking, here’s Steve Randy Waldman explaining why you should STFU. Here just the conclusion; read the whole […]

  7. jazzbumpa writes:

    You mentioned in passing that the poor die with negative wealth.

    Doesn’t this imply that their spending needs were greater than their ability to spend?

    Doesn’t that suggest that if they had a little more, they would spend every penny of it?

    Nor does it have to be technology driven. Maybe they get a third meal one day a week, a better pair of shoes for the kids or a new pair more often, a five-year-old instead of a seven-year-old used car.

    Still – the economic and the moral considerations converge at the low income level. It’s true that economics is not a morality play. However well or ill we understand it, econ, as a natural phenomenon, is a brute force, like gravity. That’s why humans with a moral compass need to intervene. We don’t let gravity keep us from building bridges.

    JzB

  8. JW Mason writes:

    Steve, are you familiar with the literature on profit-led vs. wage-led demand? If you want a more scientific approach to these questions, I think that is the place to start. The classic statement is Marglin and Bhaduri, Unemployment and the Real Wage; the best more recent development is by Lance taylor and his students. He has a good accesible discussion in Maynard’s Revenge, which unfortunately I can’t find online; there are more technical presentations in various papers; this one (with Nelson Barbosa-Filho) is probably a good place to start.

    The point is that if you take Keynesian logic seriously, it is NOT straightforward to show that higher wages lead to higher aggregate demand. It depends on a number of parameters about which we don’t have strong priors. It is perfectly possible for demand to be profit-led, or to be wage-led, and both have probably been true at different times and places. I think it’s really unfortunate that so many progressives and heterodox economists treat the idea that higher wages raise demand as something that is just true, or can be proven deductively. It’s not.

    For the contemporary US, Taylor argues (fairly convincingly IMO) that demand is probably profit-led rather than wage-led. In which case, you are wrong to say that “we reconciled inequality with growth.” Rather, rising inequality helped sustain growth, as higher profitability counterbalanced other factors that have tended to depress investment demand.

  9. stone writes:

    JW Mason@8 I also like this link about that:

    Where profits come from http://www.levyforecast.com/assets/Profits.pdf and of course the Michal Kalecki wikipedia page :) http://en.wikipedia.org/wiki/Micha%C5%82_Kalecki#The_profit_equation

    But to my mind all of that makes a STRONGER case against wealth inequality. What we need is much broader ownership of the “means of production” such that profits go to those with a higher propensity to consume so that there is more scope for more profits so that there is more growth.

    Also if current taxes were replaced with an asset tax, then I think that would give more scope for profits to be spent even if they were spent on paying the asset tax. There would still be just as much incentive to gain profits as if there was no tax. Perhaps even more incentive because otherwise assets would need to be drawn down (sorry for getting back to my pet subject again!).

    Great post by the way Steve!

  10. stone writes:

    JW Mason@8 sorry if my last comment doesn’t make sense on its own. What I guessed you were getting at is that profits come from the spending of previous profits (Kalecki profit equation). So increasing wages will reduce profits but having the workers as owners will mean that profits get recycled around such that workers can have high incomes.

  11. JW Mason writes:

    Stone-

    I think we should separate our analysis from our prescriptions. Under what circumstances will a redistribution from wages to profits reduce aggregate demand, and under what circumstances will it increase it? This is a question that can be answered rigorously, and the answer does not depend on the kind of society we might like to see.

    As for the Rawlsian property-owning democracy you suggest, I’m afraid I am unconvinced. To me, broadly distributed ownership of the means of production is being a little bit pregnant. As long as the economy is organized in the form of profit-seeking private firms, there will be a strong tendency toward concentration of wealth.

  12. stone writes:

    JW Mason@11 , I googled “pregnant” but I’m still none the wiser as to what it means in that context. Please help.

    My point is that if we are all fully in the owning class then it won’t matter at all whether and to what extent there is redistribution from wages to profits.

    I totally agree with you that there is a strong tendency towards concentration of wealth. To my mind that is why there needs to be a continuous undoing of that (by replacing current taxes with an asset tax)so that it can all continue to tick along merrily.

  13. JW Mason writes:

    I mean that an even distribution of assets, like a first trimester pregnancy, does not tick along merrily. By its nature it turns into something else…

  14. stone writes:

    JW Mason@13, Thanks for the clarification.

    The John Lewis Partnership http://en.wikipedia.org/wiki/John_Lewis_Partnership in the UK distributes all of its profits to the workers in its shops and warehouses. Also single trader businesses do that too of course. I guess those kind of ownership structures could help.

  15. kebko writes:

    A great, challenging post. It seems ironic, considering the topic, though, that the conventional idea is cited that loose monetary policy has made up for the slow growth that inequality would have produced. Why does everybody know that monetary policy has been loose when inflation has steadily declined for 40 years? That seems as crazy as the permanent income fix.

    Has high inequality been associated with high growth, which was undermined by tight money? Or maybe tight money slowed growth and created inequality?

    Should we go to molybdenum backed money?

  16. Mark A. Sadowski writes:

    “There is and has always been an obvious, intuitive, and robust stylized fact that people with higher incomes save greater fractions of their incomes than people with lower incomes.”

    We’ve been over this ground before. Repeating it ad nauseum doesn’t make it any more true than it was the first time.

    The Dynan, Skinner and Zeldes (DSZ) paper uses the CEX, SCF and PSID data which produce estimated aggregate savings rates in the range of 25%, 21% and 11-21% respectively over time periods (1980s) in which the savings rate measured by the BEA was approximately 8%-9% (see Table 2). The only data that even comes close to the correct aggregate measure is the PSID measure which uses an “active” measure of savings that effectively excludes capital gains income. This is not suprising because capital gains are not, nor should they be, considered part of GDP.

    Other studies, ones that actually produce aggregate savings rates consistent with the NIPA accounts, have shown that savings rates at times have actually been inversely related to income:

    http://www.federalreserve.gov/pubs/feds/2001/200121/200121pap.pdf

    This study in particular showed that the savings rate of the top quintile was negative in 2000.

  17. JW Mason writes:

    Mark,

    The correct treatment of capital gains is not so obvious as you imply. It’s true that at a macroeconomic level, the savings function we are interested in is savings in relation to income from current production. But if we are interested in variation across households, it’s not obvious a priori that we should assume that income from capital gains is treated differently than other income.

    In particular, it is perfectly possible that (1) households treat NIPA income and capital gains equivalently in making consumption decisions; (2) capital gains are concentrated at the top of the income distribution; and (3) there is large pro cyclical variation in capital gains income. In that case, it is perfectly possible that we will not observe a positive relationship between income and NIPA-consistent savings, but that nonetheless an upward redistribution will produce higher savings rates.

  18. Peter K. writes:

    @15 kebko

    I wouldn’t say “loose” monetary policy as the media does. How about “looser” policy? Looser than the Germans in Europe or “looser” than the Republicans would like?

    This discussions seems to get back to the Stiglitz-Krugman debate (wherein they agree about most things.)

    “Steve Roth aptly wonders why so few voices among “respectable progressives” are willing to even give fair consideration to the case that inequality might be an impediment to growth.”

    As I read the debate, Krugman doesn’t disagree with this. His discussion of secular stagnation – recently echoed by former Harvard President, Treasury Secretary and economics advisor to Obama, Larry Summers – suggests that the economy can not maintain full employment on its own without the help of unsustainable asset bubbles. This is a failure of government policy whereas Stiglitz and those who agree with him seem to suggest that even government policy can’t overcome the growth in inequality. Or possibly they are saying it just makes the government’s job more difficult.

    It’s not that inequality is an impediment, it’s that government policy is insufficient. Even in the late 90s when we had tight labor markets and labor shared in productivity gains, it was not sustainable as the tech stock market bubble popped – followed by slow job growth – and morphed into the housing bubble, which supplied unsustainable demand. The government policies were unwise – from fiscal to monetary to trade/exchange rate to supply side labor policy.

  19. stone writes:

    Mark@16, That “Why do the rich save so much?” by Christopher Carroll link makes the point that perhaps it isn’t the top 25% that matters; it is the top 0.01% or whatever. In that link it points out that at that time Bill Gates would have had to have spent $10M per day just so as to have kept even.If ultra-high-net-worth people command a greater and greater portion of ownership then that becomes a runaway feedback loop doesn’t it?

    I also think it doesn’t make a lot of sense to make a distinction between income and capital gains. The capital structure of firms can be messed around with so as to make them interchangeable can’t it? You can have share-buybacks or dividends, write call options for a volatile asset or whatever. Don’t some ultra-high-net-worths fund all their living expenses by running up debts secured on assets so that when they die they will have $multi-million debts alongside $billion dollar -that is all just for tax efficiency.

  20. Peter K. writes:
  21. Peter K. writes:

    And Krugman on calculating the missing sustainable demand caused by “secular stagnation” during the “Great Moderation.”

    http://krugman.blogs.nytimes.com/2013/12/07/secular-stagnation-arithmetic/

    “What might change this scenario? One key point could be trade. Before the 1980s, the US had more or less balanced trade. During the Great Moderation era, it ran an average current account deficit of 3 percent of GDP. Eliminating that deficit somehow would reverse most of my shortfalls. I would say, however, that the most likely way to reduce the deficit would be via a weaker dollar, achieved through low real interest rates, achieved in turn with a higher inflation target.”

  22. Claudia writes:

    Excellent post. I enjoyed the 140 character preview, and it is nice to see your argument fleshed out.

    I stick by my gut feeling (with some empirical backing) that MPCs is not the way to make the way to make the argument. It is clear (and exquisitely argued here) that empirics will never settle the inequality-growth debate but if we are going to “take a leap” in policy then I think it makes sense to leap with the most compelling argument.

    Consumption is too far down the line, too affected by preferences, and other human wackiness. And to be honest it is not always a great (or easy to measure) metric of utility or life satisfaction. I prefer to look the distribution of income and the distribution of earning potential. Yes, it’s correlated with consumption but why go that far?

    Discrimination (actual and even perceived), high incarceration rates, subpar education, rent-seeking (non internalized social costs), self-destrucive/myopic conditions, etc. can all get you a more unequal and less equitable distribution of income. Even before you decide how to spend it, that income disappointment sends a strong signal to people. Nothing about that signal can be good for growth.

    As someone who has had a lot the PIH koolaid forced down her throat, err has happily drunk the koolaid … I can’t argue with your claim that PIH only explains a portion of the variation. But it is actually a pretty great model of how people might behave if they had enough money to not live hand to mouth … or to live as if tomorrow is not just tomorrow’s problem.

    I agree with your broader point that inequality (or at least some of its sources) has to be bad for growth, but I do think the details and the framing matters too.

  23. stone writes:

    I wonder whether this whole confusion that economists have stems from their faith that people will optimize their wealth however rich they are. The way for money to earn the most (excluding by political corruption) is by investing in a way that optimizes the use of everyone’s talents and meets everyone’s desires. So in theory however unequal things are, the economy should be working perfectly because the oligarch will be lending people money so that they can buy stuff from the oligarch owned stores selling oligarch owned stuff etc etc. But even if they were to want to, no-one is up to the job of coordinating everything. Oligarchy fails for exactly the same reason as Soviet style command economies fail –because economic power is overly concentrated. A capitalist system with widely distributed economic power, channels the combined parallel decisions of everyone. That is what is needed to successfully run an economy IMO.

  24. Mark A. Sadowski writes:

    @JW Mason,
    “The correct treatment of capital gains is not so obvious as you imply. It’s true that at a macroeconomic level, the savings function we are interested in is savings in relation to income from current production…”

    But supposedly we are talking about the *macroeconomic* effect of income inequality. So the savings function we are interested in is precidely the one that is measured from current production.

    “In particular, it is perfectly possible that (1) households treat NIPA income and capital gains equivalently in making consumption decisions;…”

    The first assumption is evidently false. Again, the only data in the Dynan, Skinner and Zeldes paper that even comes close to the correct aggregate savings measure is the which uses an “active” measure of savings that effectively excludes capital gains income. Apparently that’s because households do not treat NIPA income and capital gains income equivalently in making consumption decisions. This is not something we have to guess about, it’s right there in the data.

    @stone,
    “That “Why do the rich save so much?” by Christopher Carroll link makes the point that perhaps it isn’t the top 25% that matters; it is the top 0.01% or whatever.”

    If the top 20% (or 25%) don’t have a high savings rate, then it’s almost certain that any subset of the top 20% isn’t going to have a high savings rate either.

  25. stone writes:

    Mark A. Sadowski @24, I think you are mistaken. First off, as the Carroll link explains, the relevant type of saving that is giving us secular stagnation is largely manifested as unrealized capital gains of the ultra-wealthy. That isn’t even on the radar of the stats about saving from “income” by the top 25% as explained again in the Carroll link. Face the fact that someone could have a billion dollars held as Berkshire Hathaway stock, an art collection and homes worth several hundred million dollars and for tax reasons live their entire life funded by debts run up secured on their assets (that is what they do). You economists would say that such a person wasn’t saving would you? And yet the saving of the dividends received WITHIN the holdings of the portion of Berkshire Hathaway (which is a conglomeration of dividend stocks after all) owned by that person would be sucking the economy dry like a suction pump as Marriner Eccles put it when he talked about this in 1933.
    The bottom 25% may “save from income” more than the top 25% because they don’t have a buffer stock of assets to help them ride over difficult times. That doesn’t mean that there will be more of a “Marriner Eccles suction pump effect” if more money goes to the bottom 25%.

    If economists had the job of determining whether rivers flowed uphill or downhill, we would get a century of increasingly stylized and circular discussions about whirlpools :)

  26. […] Standards of evidence Interfluidity […]

  27. Mark A. Sadowski writes:

    stone,
    “First off, as the Carroll link explains, the relevant type of saving that is giving us secular stagnation is largely manifested as unrealized capital gains of the ultra-wealthy. That isn’t even on the radar of the stats about saving from “income” by the top 25% as explained again in the Carroll link.”

    The Carroll paper essentially explains why wealthy people do not *dissave* their wealth in the course of their lifetimes. The paper may be interesting from a microeconomic perspective, but the paper does not, nor does it even pretend to have, any macroeconomic implications.

    “And yet the saving of the dividends received WITHIN the holdings of the portion of Berkshire Hathaway (which is a conglomeration of dividend stocks after all) owned by that person would be sucking the economy dry like a suction pump as Marriner Eccles put it when he talked about this in 1933.”

    A share of stock, a painting or a house are not new production taken from the stream of income. They are not taking anything away from anybody.

  28. JW Mason writes:

    Mark,

    Are you saying that the propensity to consume out of capital gains is higher than the propensity to consume out of other income? or lower?

  29. Mark A. Sadowski writes:

    JW Mason,
    The propensity to consume out of capital gains is lower than other forms of taxable income. The data which produce estimated aggregate savings rates as high as 25% includes capital gains as income. Only when capital gains is excluded do we see estimated aggregate savings rates that approach reality.

    Moreover this is in keeping with the fact that capital gains “income” is purely a tax construct arising from an asset swap. Fundamentally, the capital gains tax is a wealth tax (not that there’s necessarily anything wrong with that), not an income tax, and this is precisely where the wildly exagerated estimates of the savings rates of those with wealth/high income are coming from.

  30. […] Standards of evidence Interfluidity […]

  31. stone writes:

    Mark A Sadowski@27, “A share of stock, a painting or a house are not new production taken from the stream of income. They are not taking anything away from anybody.”

    I think this statement encapsulates the issue at stake. The key point is that new production is NOT what is limiting. We are not constrained by productive capacity. The only time we remotely came close to being so was during WWII. We are constrained by the limited demand of people with money. There are machines and people and buildings standing by idle because it is decided not to use them and to instead direct the money that could be spent employing them on share buybacks etc. So the ultra-high-net-worth individual does not take production BUT she is in control of deciding that that production never takes place and instead the money that could have employed the idle machines etc is spent on share-buy-backs or on bidding up the price of pre-existing land or classic pieces of art or whatever.
    All the resources that now are directed at having meetings about marketing strategy and such like could potentially be directed towards production if only there were sufficient demand from those with money.

    Anyway doesn’t it seem bizarre to you that your way of accounting would class someone who owns Berkshire Hathaway stock as not saving but class someone who held the individual dividend stocks that Berkshire Hathaway holds and themselves reinvests the dividends as saving even though both people are removing the same cash stream out of the economy?

  32. JW Mason writes:

    Got it, thanks.

    I am still skeptical but this is not my area so I will defer. I don’t think anything critical hinges on the claim that the MPC falls with income.

  33. Mark A. Sadowski writes:

    JW Mason,
    “I don’t think anything critical hinges on the claim that the MPC falls with income.”

    Just to be excruciatingly clear, I don’t think there is any contradiction at all between the fact that MPC falls with income and the fact that savings rates do not. One is a marginal quantity and the other is an average.

  34. Mark A. Sadowski writes:

    “…and the fact that savings rates do not.”

    should read

    “…and the fact that savings rates do not rise with income.”

  35. stone writes:

    Mark A Sadowski, “The Carroll paper essentially explains why wealthy people do not *dissave* their wealth in the course of their lifetimes. The paper may be interesting from a microeconomic perspective, but the paper does not, nor does it even pretend to have, any macroeconomic implications.”

    IMO that phenomenon of wealth gathering more financial power in the form of unrealized capital gains is the key phenomenon at the heart of macroeconomics.

  36. Mark A. Sadowski writes:

    stone,
    “The key point is that new production is NOT what is limiting.”

    You’re getting fixated on semantics. In order for the underconsumption thesis to have merit it must be shown that income derived from new production is not being spent. It does absolutely no good to focus on the fact that an antique painting somewhere may or may not have appreciated in value.

    “We are constrained by the limited demand of people with money.”

    I strongly disagree. There is loads of anecdotal evidence that people with money are spending it like drunken sailors. It is in fact the luxury segment of the economy that has recovered first and best.

    “Anyway doesn’t it seem bizarre to you that your way of accounting would class someone who owns Berkshire Hathaway stock as not saving but class someone who held the individual dividend stocks that Berkshire Hathaway holds and themselves reinvests the dividends as saving even though both people are removing the same cash stream out of the economy?”

    No. When dividends are used to purchase stock someone or something obviously has also also sold the stock in exchange for dividends. The dividends do not magically vanish from the income stream of the economy.

  37. Mark A. Sadowski writes:

    stone,
    “IMO that phenomenon of wealth gathering more financial power in the form of unrealized capital gains is the key phenomenon at the heart of macroeconomics.”

    IMHO that is the most over the top BS statement I have read in any econblog in quite some time.

  38. stone writes:

    Mark A Sadowski: “No. When dividends are used to purchase stock someone or something obviously has also also sold the stock in exchange for dividends. The dividends do not magically vanish from the income stream of the economy.”

    It creates asset price inflation, bidding up volatility in the stock price. We end up with claims on wealth increasing relative to the real economy.

  39. Mark A. Sadowski writes:

    Stone,
    “We end up with claims on wealth increasing relative to the real economy.”

    Frankly I fail to see why this is at all relevant to the idea that the wealthy are contributing to underconsumption. Asset swaps are not the issue.

  40. stone writes:

    Mark A. Sadowski@39: “Frankly I fail to see why this is at all relevant to the idea that the wealthy are contributing to underconsumption. Asset swaps are not the issue.”

    The whole point of it all is that the asset swaps are for more and more money with each exchange. That causes just as much “leakage to savings” as if the money were taken out as green backs and stuffed in a mattress. It is what it is all about IMO. People pay for their living expenses and a cut is taken out of that as profits and is used to bid up asset prices. The stock of wealth held as previously existing securities and real estate increases and the flow of funds to pay for subsequent profits and consumption is diminished. The saving conducted in that way has a correlate in the form of “investment” in the form of unsold inventory that perishes and goes to waste prompting firms to reduce production and cut back on getting more machines etc.

  41. JW Mason writes:

    I don’t think there is any contradiction at all between the fact that MPC falls with income and the fact that savings rates do not

    Uh oh.

    C = C0 + cY.

    S = Y – C

    S = Y – C0 – cY

    S/Y = (1-c) – (C0/Y) = s – C0/Y

    If C0>0, then a constant marginal propensity to consume implies an average savings rate that rises with income.

    If MPC falls continuously with income, then above some income threshold average savings rate must rise with income, regardless of C0.

    If there is some range of incomes over which the marginal propensity to consume falls but the average savings rate does not rise, that implies C0<0.

    I don't see how you can tell a sensible behavioral story in which marginal to propensity to consume falls with income but average savings rate are constant. Because logically, that implies consumption falls to zero at some positive income, when by contrast we know that consumption remains positive even when income is zero.

    If you think savings rate don't rise with income, you should also think that the MPC does not fall with income.

  42. Greg writes:

    The notion that the wealthy are “under consuming” is the wrong reading of the inequality argument. The wealthy are not under consuming its the rest that are under consuming because they are either A) suffering income loss form job loss B) spending less because they fear pay cuts or job losses in near future C) focusing on paying off past consumption (debts) in lieu of present consumption. The “underconsumption of the wealthy” is a straw man in my view. No one should be arguing that is the current problem. Expecting the wealthy to buy 4 cars instead of 2, buy food for 12 instead of 4 or purchase clothing and televisions they don’t need is silly. They are buying all they have ever bought, in some cases even more (housing in distressed areas) but they are buying at a lower price so the seller is making less income and they aren’t buying it from one of the non wealthy. They are buying homes form banks for fire sale prices and renting them back to previous owners.

    The inequality is not a cause of our problems, its the result of them. We ended up here because of specific policies. If we don’t change those policies we will stay here.

  43. Mark A. Sadowski writes:

    @stone,
    “The whole point of it all is that the asset swaps are for more and more money with each exchange.”

    But no money disappears because of the asset swap. It simply changes hands.

    @JW Mason,
    You’re assuming C0 is a constant. Suppose instead that C0 is dependent on the wealth/income class you’re born into. In my opinion this much more closely matches what we actually observe empirically.

  44. stone writes:

    Mark A Sadowski, ultra rich people “not dissaving” as their assets appreciate in value means that people saving for retirement have to pay higher prices for stocks so get lower returns so their pension providers insist on a greater portion of wages going towards pension savings. That leaves less money for consumption. It also means homes are held as rental properties and so fewer are available to buy so they become more expensive so homebuyers spend a greater proportion of wages on housing and that leaves less money for consumption.

    so overall “not dissaving” causes saving

  45. JW Mason writes:

    OK. Maybe. Hm…

  46. Rob Lewis writes:

    Liberals can’t seem to resist falling back on a “make the rich pay their fair share” argument. But, as discussed here:
    http://www.dailykos.com/story/2012/11/25/1164564/-Taxing-the-rich-it-s-not-about-fairness
    it’s not about fairness. It’s about the negative externalities of excessive wealth concentration. Includes a comment by Robert Reich.

  47. Mark A. Sadowski writes:

    stone,
    “ultra rich people “not dissaving” as their assets appreciate in value means that people saving for retirement have to pay higher prices for stocks so get lower returns so their pension providers insist on a greater portion of wages going towards pension savings. That leaves less money for consumption.”

    Wealthy people who do not dissave should have little to no impact on asset prices in aggregate. They could drive asset prices down by dissaving, but I doubt they can drive them up by not dissaving.

    “It also means homes are held as rental properties and so fewer are available to buy so they become more expensive so homebuyers spend a greater proportion of wages on housing and that leaves less money for consumption.”

    There’s no rule that says people have to own houses. Renting is always an option and may often be preferable. And if property acquisition should somehow drive up the cost of consuming shelter this would show up in inflation, which given its current low level obviously is not happening.

  48. rsj writes:

    I though the MPC issue was conclusively settled with Carrol and Kimball’s ‘On The Convexity of the Consumption Function’, in which they prove that in a generic HARA utility function and a model with additive income risk, the consumption function is a strictly concave function of wealth in all but a few degenerate cases.

    The source of the concavity is Jensen’s formula, and the degenerate cases are those in which the derivative of the consumption function is has a symmetry containing the risk. So, for example, CES utility is symmetrical with respect to multiplicative risk and so it is very easy to get analytical results if you ignore additive income risk (e.g. labor income which adds to wealth in each period) and consider only multiplicative risk (e.g. risk in returns on assets) but as a side-effect of these assumptions the consumption function appears to not depend on wealth at all. If you slightly perturb the utility function, or if you introduce a source of risk that is not a symmetry of the marginal utility, you are back to the standard story of decreasing MPC as wealth increases.

    So why are we still debating the existence of something for which there is a mathematical proof in standard models? It is sheer laziness in assuming that models that give nice analytical results due to the choice of some very special utility functions that provide for a lot of cancellations of terms need to be representative and we can conclude that something like the consumption function is independent of wealth for optimizing agents as a generic economic truism. This is similar to Gaussian Copula fiasco or other assumptions in which a very special form of utility or risk is assumed that admits an analytical solution and we then build our intuition on a result which is not robust to deformations of the special assumptions that allow for analytical tractability.

  49. Mark A. Sadowski writes:

    rjs,
    “So why are we still debating the existence of [the MPC] for which there is a mathematical proof in standard models?”

    To be clear I don’t think anybody is debating the fact that MPC decreases as income increases.

    I claim that that MPC decreases with income while the savings rate does not increase with income. The concave consumption function that Carrol and Kimball derive results in an MPC to consume out of wealth or transitory income that declines with the level of wealth, and that model appears to be consistent with my claims:

    http://www.econ2.jhu.edu/people/ccarroll/concavity.pdf

  50. stone writes:

    Mark A Sadowski @47 “Wealthy people who do not dissave should have little to no impact on asset prices in aggregate. They could drive asset prices down by dissaving, but I doubt they can drive them up by not dissaving.”

    So basically are you denying the possibility of asset price inflation? Are you saying that a fixed stock of assets can have a large subset sequestered as “never to be dissaved by the ultra-wealthy” and that not effect the price of the remaining stock that is being bid for by everyones’ pension savings?

    IMO our whole system relies on a cycle of saving and dissaving. People have differing needs and earning capacities at different times of life and need to even those out. Across the economy as a whole, no problem arises from individuals saving so long as for everyone saving there is someone else drawing down savings (for instance retirees drawing down retirement savings). If economy-wide net saving is occurring, that also isn’t a problem if it is simply a reflection of rational increases in tangible investment in productive capacity. Problems arise from non-productive net saving across the economy. When saving is used to defer consumption the primary resource that is being “transported through time” is a claim over other peoples’ labour. We decide not to pay for a restaurant meal today so that we instead may pay for nursing care in fifty years’ time. This system works very well if various people are saving and drawing down savings at any given time so that overall there is no net saving. Obviously however net saving across the economy cannot achieve the impossible. If all restaurant staff are left idle today then that cannot miraculously conjure up nursing capacity in fifty years’ time. One tragic limitation of money is that it renders everything down into an imperishable abstraction. What is done with money gets mirrored by what consequently gets forced on the real world even if that entails unintended waste. Because every unused man-hour is permanently lost, a conflict arises between the imperishable monetary savings and the lack of any reflection of those savings remaining in the real economy in the form of capacity to honour that claim on future production. That leaves us with an underconsumption crisis and the need for huge government deficits along with the economic distortions and political issues those create.
    Once deficits have built up a huge stock of excess paper financial claims, we then get political lobbying for deflationary austerity as a way to try and preserve the financial power of those financial assets.

  51. stone writes:

    Mark A Sadowski@50: “The concave consumption function that Carrol and Kimball derive results in an MPC to consume out of wealth or transitory income that declines with the level of wealth, and that model appears to be consistent with my claims”

    So it all boils down to you seeing some great distinction between “income” and “non-MarkASadowski-income” increases to stocks of personal wealth”?

    IMO the only way to get a coherent grasp on this is to recognize that positive changes in wealth together with consumption needs to be the operational definition for “income”. If you use your super restrictive view of income, then yes you can come up with some pretty offbeat impressions. I’m sure that if you had an even more restrictive view of income then even you do -such as only counting income received in the form of green paper folding money, then an even more offbeat impression could develop. At a push, you could even restrict your view of income as only being income in the form of coins. After all federal reserve notes are sort of a perpetual bond, only coins are real money. Then you really would confuse yourself.

  52. stone writes:

    Perhaps I should have written @50 that positive changes in wealth needs to be the operational definition for “saving”. BUT I do appreciate that it is very important not to mess around with definitions or otherwise communication becomes impossible. If Mark A Sadowski’s definitions of income and saving are the official ones- then it is important to respect that -sorry. What is needed is to still talk about the factors that really matter and to use unambiguous phrases for those I guess. So I should say stuff like “positive changes in wealth” rather than saying “saving” when the definition isn’t the official one?

  53. Jon Cloke writes:

    It is self-evidently stupid to claim that taxes are bad for growth in the current, bubble-driven ‘irrational exuberance’ of the FTSE, DOW, etc. The whole financial services sector has been back-stopped globally by the state, using taxpayers’ money to replace the liquidity which dried up in 2007 and which still would be completely absent if not for the taxpayer’s largesse.

    Where has the current ‘growth’, this amazing ‘recovery’ in the UK and US come from, if not from hosing down a fundamentally and irretrievably broken financial services sector with tax money and telling the banks “It doesn’t matter what you do or how stupidly you behave, we won’t let you go under”?

    As to the sustainability of that growth, well that’s another question. But say, weren’t those Tax Foundation folks the same people who used to talk about the ‘private sector crowd-out’ effect that led to the graven idol of Austerity being worshiped? And didn’t they claim that the massive bail-outs would lead to hyper-inflation? Caedite eos, novit enim deus qui sunt eius…

  54. Luis Enrique writes:

    a tangent: I am not sure why Christopher Carroll is “courageous” as opposed to a very high status mainstream economist, nor why somebody who comes up with an idea that revitalises PIH would die rich (I’m sure Carroll is paid handsomely). I don’t think the idea that wealth has something to do with the MPC is apostasy to mainstream econ.

  55. Mark A. Sadowski writes:

    stone,
    The empirical evidence suggests that savings rate do not increase with income (even if the MPC decreases with income). That’s all I am saying.

    I think it’s important to get the facts right in any macroeconomic discussion and I think it is particularily important in this context because we are touching on the underconsumption thesis for which I believe the evidence is rather weak.

    If you want to talk about the fact that wealth and income concentration are greater than they probably have ever been in the history of the US, what the actual causes are, and what the economic and social implications of this are, I’m all ears. But the only way we’ll ever approach some consensus is by sticking to the facts.

  56. stone writes:

    Mark A. Sadowski@55, I totally agree with you about the importance of facts. I’m just saying that you fail to get the relevant fact if you measure the wrong thing. Your narrowly defined income measure has caused you to fail to see the MASSIVE phenomenon that is behind the underconsumption.

    Don’t you recognize that the tax code causes rich people to arrange their affairs such that the benefits of their riches accrue to them is any which way according to what is most tax efficient?

    Currently the tax code happens to be such that rich people ensure that benefits accrue to them by way of unrealized capital gains and not as income. BUT that is just an artifact of the current tax code.

    If, for whatever reason, the tax code were changed so that unrealized capital gains were subject to a 20% charge (like the 20% charge hedgefunds charge clients) and wages were exempt from tax, then you would immediately see rich people not having much capital gains and becoming employees of holding companies of their assets that paid them vast salaries.

    I’m scratching my head about this not being obvious to you.

  57. stone writes:

    Mark A Sadowski@55, to give an illustration of my point @56,

    Person A currently gets capital appreciation of say $1B per year and income of $1M per year. She spends $1M per year.

    Person B currently has no capital appreciation and gets income of $20k per year. She saves $2k per year.

    You would say that that sort of behavior disproves the underconsumption hypothesis would you?

    BUT then the tax code changes. Person A changes her affairs such that she now has $1.1B income per year and no capital appreciation. She spends $1M per year on living expenses just as before and now buys more assets with the remaining $1B (which you now would now see for the saving that it is). BUT the underlying cash flow from the assets held is just what it was before. The only difference is tinkering with the capital structure. Dividends are paid rather than share-buybacks. Companies spin off small companies rather than conducting mergers etc etc. The macroeconomic effect from underconsumption is no more and no less than what it was before.

  58. Mark A. Sadowski writes:

    stone,
    “Don’t you recognize that the tax code causes rich people to arrange their affairs such that the benefits of their riches accrue to them is any which way according to what is most tax efficient?”

    Capital gains is a wealth tax that has caused confusion as to the difference between income and wealth.

    “Currently the tax code happens to be such that rich people ensure that benefits accrue to them by way of unrealized capital gains and not as income.”

    The existence of the capital gains tax has mostly encouraged people to time their realized gains to minimize taxation. It doesn’t reduce the amount of asset appreciation taking place. Slemrod has a very good paper on this.

    “If, for whatever reason, the tax code were changed so that unrealized capital gains were subject to a 20% charge (like the 20% charge hedgefunds charge clients) and wages were exempt from tax, then you would immediately see rich people not having much capital gains and becoming employees of holding companies of their assets that paid them vast salaries.”

    The taxation of private equity and hedge funds is actually a good example. Because the manager is compensated with a carried interest in the fund, the bulk of its income from the fund is taxed, not as compensation for services, but as a return on investment. But the point is nobody is fooled by this tax gimmick as everybody knows that her income is really derived from performing a service.

    “BUT then the tax code changes. Person A changes her affairs such that she now has $1.1B income per year and no capital appreciation. She spends $1M per year on living expenses just as before and now buys more assets with the remaining $1B (which you now would now see for the saving that it is). BUT the underlying cash flow from the assets held is just what it was before. The only difference is tinkering with the capital structure.”

    That’s not all that changes in your hypothetical example. The GDP of person A and B has increased from $1,020,000 to $1,100,020,000. Are you seriously arguing that a change in the tax structure could result in GDP going up by an amount equal to realized capital gains?

  59. Greg writes:

    @Sadowski

    “Wealthy people who do not dissave should have little to no impact on asset prices in aggregate. They could drive asset prices down by dissaving, but I doubt they can drive them up by not dissaving”

    This makes no sense at all. Dissaving means “selling” and not dissaving means “buying” when it comes to assets. If I am buying them I am saving (not dissaving) so of course if wealthy people are generally selling the asset prices will be falling if they are generally buying the asset prices will be rising. You dont think buying assets puts upward pressure on the prices of them?

  60. stone writes:

    Mark A. Sadowski@58, I do think if the tax code were different, income would leap up phenomenally. I was actually saying that rich people now receive benefits as unrealized capital gains and that the hypothetical tax would be on appreciation of wealth irrespective of whether gains were realized and furthermore that gains from wages were tax exempt -so the total opposite tax regime from that at present. People who currently have billion dollar increases in net worth year on year would still have billion dollar increases in net worth and yes in many cases they would now have >1000x increases in “income” BUT just the same annual increases in net worth as they exhibited under the old tax code.

    It makes a chalk and cheese difference whether companies try and create increases in share price or try and avoid them. Companies could prevent any increases in share price simply by paying more dividends and issuing extra shares as fast as buyers purchased them -the opposite of the current policy of trying cause share price appreciation and avoid income.

    We are talking about people such as those in the Carroll study who accumulate to accumulate and anyway couldn’t possibly be expected to do otherwise since they have wealth increasing by $1M per day or whatever. They never hope to draw down those “savings” -or whatever you would like to call them -non-dissavings or whatever.

  61. Mark A. Sadowski writes:

    Greg,
    “Dissaving means “selling” and not dissaving means “buying” when it comes to assets.”

    The negation of a statement does not mean its opposite. Not selling does not mean buying.

  62. Mark A. Sadowski writes:

    stone,
    “It makes a chalk and cheese difference whether companies try and create increases in share price or try and avoid them. Companies could prevent any increases in share price simply by paying more dividends and issuing extra shares as fast as buyers purchased them -the opposite of the current policy of trying cause share price appreciation and avoid income.”

    It makes no difference at all to corporate profits, and hence to GDP, whether firms pay more dividends and issue extra shares or not.

  63. stone writes:

    Mark A Sadowski@62, I didn’t really mean for those two people to be the entire hypothetical economy. It is you who is making these inferences about GDP. I haven’t considered that.

    In both cases I gave, corporate profits for the holdings of person A were the same $1.1B weren’t they? In the first case those profits were almost all dispersed by share buybacks or retained as corporate cash reserves or used to buy stock of other companies (as per Berkshire Hathaway) leading to capital appreciation whilst in the second case they were paid out as income that person A spent buying more shares and those shares were newly issued by the companies she held.

    Both cases have the same corporate profit causing the same increase in the value of person A’s portfolio. The only difference is that in the second case the cash flow is transiently handled by person A (or her asset manager) as she buys more shares whilst in the first case the firms do that themselves behind the scenes on her behalf.

    The difference is that you recognize dividends as income whilst you seem to overlook the ways that benefits can accrue via capital appreciation.

  64. Mark A. Sadowski writes:

    stone,
    “I didn’t really mean for those two people to be the entire hypothetical economy. It is you who is making these inferences about GDP. I haven’t considered that.”

    There’s a very good reason I keep coming back to GDP. Asset price appreciation isn’t part of GDP because wealth is not the same as income. Capital gains are not part of GDP.

    “In both cases I gave, corporate profits for the holdings of person A were the same $1.1B weren’t they?”

    No, capital appreciation is not the same as corporate profits. One is an increase in wealth and the other is income.

  65. rsj writes:

    Mark,

    The consumption function for an optimizing agent is a function of wealth, not income. Each period you decide how much of your wealth to spend on consumption and how much to save for the future. In very special cases (e.g. with utility functions that are are exponential or just a power law), we can say that the derivative of the consumption function is a multiple of the derivative of wealth (which is income). Then we can talk about the marginal propensity to consume out of marginal changes to wealth, e.g. out of income. In general, it is not the case that consumption divided by wealth is well defined as a function of the derivative of wealth alone.

    But even if it is true, income needs to include everything that will add to wealth in order for the above derivation to make sense.

    In Carroll and Kimball’s model, they assume that current income is equal to permanent income plus a stochastic term. This creates additive risk.

    In this model, people will have two sources of savings demands: one for consumption smoothing as in the perfect foresight case, and additionally a precautionary saving demand. The latter demand becomes less important as wealth increases. They then take the limit of the infinitely lived agent and find that this agent will want to permanently hold a buffer stock of savings that is a multiple of their permanent income.

    In that case, a random change to their current wealth will cause them to want to save more to get back to the ideal current wealth to permanent income ratio.

    The reason why a small change in wealth (e.g. income) will cause the poor person to consume a greater proportion of their wealth is because the poor person is saving more as a result of the precautionary saving demand, and giving them more wealth makes them less poor, which causes the precautionary saving demand to decrease. In this sense the consumption function is a strictly concave function of wealth. It doesn’t make sense, in the general case, to think of the consumption function as being defined as a function of current (or even permanent) labor income.

    Moreover I don’t see why NIPA accounting matters at all here. If I find gold on my property, does it make a difference if I rent the property for more money each period, or sell it now and take delivery of the discounted flow of rents all at once? In both cases, my consumption will change even though in one case I will take one time capital gain and in the other case I take a sequence of increased rental payments. The effect on satiating precautionary savings demands should be the same in both cases.

  66. stone writes:

    Mark@64, Lots of companies are profitable and yet do not pay dividends. I gave the example of Berkshire Hathaway but there are many many others. And it is in many cases the firms saving on behalf of their shareholders NOT a case of the firms investing in the economic sense of replacing machinery etc.

    That saving by the firms is what I mean. However you fail to see the connection between that saving and the ultra-rich beneficial shareholders of those firms -so you come to the (IMHO wrong)conclusion that ultra-rich people are not connected to economy wide net saving and underconsumption driven secular stagnation.

    I’m totally with RSG that the real world only starts to make sense if you think about increases of wealth rather than looking at some narrowly defined type of income.
    It gets even more awkward but just as important when asset price inflation into other non-earning stores of value is drawn into the picture.

  67. Mark A. Sadowski writes:

    rjs,
    I am indifferent to whether it is more correct to say that MPC is a decreasing function of income, wealth or both. However, in general I think it is important not to conflate changes in wealth with income, as empirically we know they are not identical.

    “Moreover I don’t see why NIPA accounting matters at all here. If I find gold on my property, does it make a difference if I rent the property for more money each period, or sell it now and take delivery of the discounted flow of rents all at once? In both cases, my consumption will change even though in one case I will take one time capital gain and in the other case I take a sequence of increased rental payments. The effect on satiating precautionary savings demands should be the same in both cases.”

    Assume the entire economy consists of you and myself, and that GDP (personal income) is equal to the rent generated by the property. Under NIPA the aggregate savings rate would be identical whether you rent the property or sell it to me. Under IRS accounting, even though our consumption is identical in each case, our aggregate savings rate would be far higher if you sell the property than if you rent it to me because your capital gain would count as income.

  68. Mark A. Sadowski writes:

    stone,
    “Lots of companies are profitable and yet do not pay dividends. I gave the example of Berkshire Hathaway but there are many many others. And it is in many cases the firms saving on behalf of their shareholders NOT a case of the firms investing in the economic sense of replacing machinery etc.”

    Nevertheless, profits, and thus GDP will be identical whether those firms pay dividends or not.

    “I’m totally with RSG that the real world only starts to make sense if you think about increases of wealth rather than looking at some narrowly defined type of income.”

    From the standpoint of macroeconomics, the only definition of income that we should be interested in is GDP.

  69. rsj writes:

    Mark,

    However, in general I think it is important not to conflate changes in wealth with income, as empirically we know they are not identical.

    They are not the same, but this doesn’t mean that one is more important than the other. Most people, for example, don’t hold much wealth in the form of stock shares, as this is primarily reserved for the wealthy. The majority holds few shares of stock and those are held indirectly by claims on pension funds and in retirement accounts which cannot be sold off as needed to smooth current period income. On the other hand most people do hold some equity in a property. Therefore you would expect increases in land prices to generate more consumption than increases in share prices. But you would not expect this effect to be smaller in nations with much better wage insurance or lower employment risk.

    So yes, the story between financial wealth versus land wealth versus labor income is messy, but there is no theoretical reason to explain why labor income is somehow fundamentally more important than changes in capital gains. See, for example, Carroll’s “How large are financial and housing wealth effects?”.

    About your IRS example, if you do not want to pay taxes all at once as a result of selling the asset outright, you can borrow to pay the lump sum tax payment and spread the payments out over time, just as you would have a time series of tax obligations by renting out the property. I don’t see how this distinction is important.

    Moreover, I hope that this can be internalized as a truism: no one receives NIPA income. NIPA income is an ex-post measure defined only for an aggregate economy, not an individual household. Optimizing households are not working with NIPA income. NIPA income can converge to individual income over the long term under some certain critical valuation assumptions which, importantly, do not hold. For example,

    If I own a share of stock in a firm that cannot sell goods, then the market price of the firm drops and my wealth decreases, causing a decline in my income, but according to NIPA, I am paid in inventory and my income increases. Clearly there are some important assumptions about market clearing and valuation (e.g. expectations) that are required to hold for NIPA income to be equal to household income. But we are interested in studying how these assumptions fail to hold, and this course of study is harmed by assuming that households take delivery of NIPA income.

  70. Mark A. Sadowski writes:

    rjs,
    “They are not the same, but this doesn’t mean that one is more important than the other.”

    The issue is not whether one is more important than the other. The issue is which one is actually relevant.

    In underconsumption theory recessions and stagnation arise due to inadequate consumer demand relative to the production of new goods and services. Consequently it is precisely the income that is derived from the production of new goods and services that is connected to the matter of whether underconsumption is actually taking place. The income derived from the buying and selling of assets is completely peripheral given the very nature of underconsumption theory.

    “About your IRS example, if you do not want to pay taxes all at once as a result of selling the asset outright, you can borrow to pay the lump sum tax payment and spread the payments out over time, just as you would have a time series of tax obligations by renting out the property.”

    I never mentioned “taxes”. The only reason why I brought up “IRS income” is because that is the only context where capital gains are even referred to as “income”. Capital gains only relate to the buying and selling of assets and hence are not income in the conventional sense of that which is derived from the production of new goods and services. My point in making the comparison was that referring to capital gains as income will produce a measure of savings that is wildly inflated compared to the more normal measure of savings out of the income derived from the production of new goods and services, which is of course the measure of savings relevant in this context.

    “Moreover, I hope that this can be internalized as a truism: no one receives NIPA income.”

    Frankly, this is bordering on the ridiculous. Nearly everyone receives NIPA income, and given that the income derived from the production of new goods and services is the measure of income that is relevant to underconsumption theory, that is the measure of income that I think we obviously should try and stay focused on.

  71. stone writes:

    Mark A Sadowski @70, “In underconsumption theory recessions and stagnation arise due to inadequate consumer demand relative to the production of new goods and services. Consequently it is precisely the income that is derived from the production of new goods and services that is connected to the matter of whether underconsumption is actually taking place. The income derived from the buying and selling of assets is completely peripheral given the very nature of underconsumption theory”

    This is wrong in my opinion. What matters is not “consumer demand relative to the production of new goods and services”, it is consumer demand relative to what the feasible supply of goods and services would be IF available resources were made use of. Those are VERY different things. The waste is not so much the unsold inventory that perishes, it is the potential that never gets to the point of becoming inventory- ie unused machine time, underemployment of willing labour, deployment of labour towards sitting in marketing strategy meetings etc etc.
    It is buying and selling of assets that apportions the financial power that determines whether or not machines and people make use of their potential or sit idle on the sidelines.

  72. stone writes:

    Mark A Sadowski, imagine if overnight the tooth fairy were to redistribute global asset holdings such that in the morning, all seven billion of us on earth had an equal share; don’t you think that would give a crazy jolt to demand? Billions of people would be demanding clean water, health care, refrigerators, education etc etc. Firms would be scrabbling to invest in new productive capacity. They certainly would not have piles of excess cash for share buybacks.

    Basically people like the hypothetical “person A” described in @57 above are the gatekeepers who decide how big the economy is depending on whether they do or don’t choose to “dissave” as you put it -either to consume or to tangibly invest (ie making new capital goods etc). Current GDP is irrelevant. All that matters for determining potential NGDP is wealth and availability of credit and the decisions of the people who have it. All that matters for determining potential real GDP is that and also real productive capacity -which is immensely more than we currently deploy.

  73. Mark A. Sadowski writes:

    stone,
    “What matters is not “consumer demand relative to the production of new goods and services”, it is consumer demand relative to what the feasible supply of goods and services would be IF available resources were made use of…The waste is not so much the unsold inventory that perishes, it is the potential that never gets to the point of becoming inventory- ie unused machine time, underemployment of willing labour, deployment of labour towards sitting in marketing strategy meetings etc etc.”

    More simply put, it is underconsumption relative to the level of consumer demand needed to attain the potential GDP of new goods and services (i.e. full employment).

    “It is buying and selling of assets that apportions the financial power that determines whether or not machines and people make use of their potential or sit idle on the sidelines.”

    It is the demand for new goods and services that determines whether or not physical capital and labor are employed in the production of new goods and services. Underconsumption theory hypothesizes that consumer demand is too low relative to potential output because of excessive savings out of the income derived from the production of new goods and services.

    “…imagine if overnight the tooth fairy were to redistribute global asset holdings such that in the morning, all seven billion of us on earth had an equal share; don’t you think that would give a crazy jolt to demand?”

    Of course, this would be tantamount to those with low levels of wealth experiencing a capital gain and those with high levels of wealth a capital loss. Given previous expectations for consumption and wealth and the corresponding MPCs, this would lead to more consumption in aggregate in the near term.

    “All that matters for determining potential NGDP is wealth and availability of credit and the decisions of the people who have it.”

    This is another one of those excessively effusive way over the top statements. There are a lot of factors that determine the level of potential GDP, and it is not something which can be dramatically changed overnight.

    “All that matters for determining potential real GDP is that and also real productive capacity -which is immensely more than we currently deploy.”

    Possibly, but in the case of the US I would settle for a level of production which simply corresponds to the CBO’s estimates of potential GDP and the natural rate of unemployment.

  74. stone writes:

    Mark A Sadowski@73, “I would settle for a level of production which simply corresponds CBO’s estimates of potential GDP and the natural rate of unemployment”

    Isn’t “natural rate of unemployment” a totally nonsensical concept? It goes up and up the longer the slack economy keeps swathes of the population economically excluded and so lacking work experience. Potentially we could have a situation where a handful of oligarchs just need to employ a handful of staff and everyone else is economically excluded -living as scavengers. Perhaps only 99%. Obviously if the 99% had the funds, they would employ each other but your view would fail to see that.
    Inflation could be eliminated with an asset tax at the same time as having demand pushed so hard that employers need to develop robots to do the work. Innovation will meet increased demands. Think of the level of innovation and demand in WWII.

    Also, we are in a global economy now. I think it is a mistake to think of the USA in isolation from the rest of the world. US citizens choose whether or not to invest abroad, to buy stuff from abroad and to sell stuff abroad. Much of US under-utilization of capacity could be eliminated if the USA were pumping out exports as would be the case if much of the rest of the world could afford to pay for them.

  75. stone writes:

    Sorry, a glitch in my comment @74, “Perhaps only 99%”

    should read:

    “Perhaps only 99%”

  76. stone writes:

    Sorry, I just realized we cant use greater than symbols here without loosing text,

    in my comment @74, “Perhaps only 99%”

    should read: “Perhaps only 1% of the population would be suitable for employment by the oligarchs with the rest being uncouth, thieving, savages. Then the “natural rate of unemployment” would be 99%.”

  77. Mark A. Sadowski writes:

    stone,
    “Isn’t “natural rate of unemployment” a totally nonsensical concept?”

    It’s a point of reference. As it is unemployment has been above the natural rate for 38 out of the last 48 quarters or nearly 80% of the time.

    “It goes up and up the longer the slack economy keeps swathes of the population economically excluded and so lacking work experience.”

    All the more reason to keep unemployment lower than it has been for the last 12 years.

    “…but your view would fail to see that.”

    I don’t think we have really even discussed my views. The only think I have stressed so far is the need to remain faithful to relevant empirical evidence.

    “Inflation could be eliminated with an asset tax at the same time as having demand pushed so hard that employers need to develop robots to do the work. Innovation will meet increased demands.”

    Now you’re veering into science fiction.

    “Think of the level of innovation and demand in WWII.”

    The only innovation that took place during WW II was in weapon technology (that and aircraft welding techniques). The demand for weapons was high whereas the demand for things that were socially useful was severely limited. I could deliver a long lecture on this topic alone.

    “Also, we are in a global economy now. I think it is a mistake to think of the USA in isolation from the rest of the world. US citizens choose whether or not to invest abroad, to buy stuff from abroad and to sell stuff abroad. Much of US under-utilization of capacity could be eliminated if the USA were pumping out exports as would be the case if much of the rest of the world could afford to pay for them.”

    Perhaps, but realistically the only thing US citizens really can have an impact on is the conduct of economic policy in the US. Furthermore, the fact that US imports more than it exports kind of undercuts the whole idea that the US is underconsuming, doesn’t it?

  78. PeterN writes:

    I don’t know about saving, but the case seems clear enough with savings

    Median value of net worth for families with holdings
    Percentile of income
    Level (thousands of 2010 dollars)
    0-20 20-39.9 40-59.9 60-79.9 80-89.9 90-100 GDP
    1989 3.0 40.6 70.2 112.1 222.6 655.2 8840
    2010 6.2 25.6 65.8 128.6 286.6 1194.3 14996
    ————————————————————————–
    3.2 -15.0 16.5 64.0 539.1 6165 change in $
    107% -21% 14.7 % 29% 82% 70% total %
    3.5% -0.91% 0.66% 1.22% 2.89% 2.56% annual rate

  79. Peter N writes:

    @Mark A. Sadowski

    “That’s not all that changes in your hypothetical example. The GDP of person A and B has increased from $1,020,000 to $1,100,020,000. Are you seriously arguing that a change in the tax structure could result in GDP going up by an amount equal to realized capital gains?”

    In this particular case, the answer would be yes, it would. The salary, as an expense to the fund and income to management would be part of GDP. The fund would have a greater capital gain in compensation and thus the same ending balance in either case.

    Another example is whether a company pays dividends or uses the money to purchase its own stock. The dividends are income. The increase in stock value is capital gains.

    Or say I’m a song writer. I can receive royalties or sell the rights to receive them. That’s how Michael Jackson ended up owning the Beatles’ songs. The Beatles needed a tax break and took Northern Songs public.

    There are lots of ways to choose whether to receive income or capital gains. What do you think all that money is spent on accountants for? GDP is a crude and arbitrary measure of production, which itself, isn’t well defined when you consider services and unpaid work.

    Have Linux, Wikipedia and the work of the IETF added nothing to GDP?

  80. Mark A. Sadowski writes:

    Peter N,
    “I don’t know about saving, but the case seems clear enough with savings”

    “Savings” (i.e. net worth) tells us almost nothing about the savings rate.

    “The salary, as an expense to the fund and income to management would be part of GDP. The fund would have a greater capital gain in compensation and thus the same ending balance in either case.”

    Capital gains are not part of GDP.

    “Another example is whether a company pays dividends or uses the money to purchase its own stock. The dividends are income. The increase in stock value is capital gains.”

    Dividends and the money used to purchase stock both came out of profits and hence are part of GDP.

    “I can receive royalties or sell the rights to receive them.”

    The production of new intellectual property is part of GDP.

    “There are lots of ways to choose whether to receive income or capital gains.”

    There many ways of reducing one’s tax burden. But capital gains are not part of GDP.

  81. stone writes:

    Mark A. Sadowski@80

    You are saying that “Dividends and the money used to purchase stock both came out of profits and hence are part of GDP.”

    and yet you are saying that rich people “not dissaving” stocks (as they are being bid up by share buybacks) should not be viewed as rich people saving.

    So it looks to me as though you are recognizing that the saving is happening, it is just that you are denying the connection to the rich people?

  82. Mark A. Sadowski writes:

    stone,
    “and yet you are saying that rich people “not dissaving” stocks (as they are being bid up by share buybacks) should not be viewed as rich people saving.”

    If a corporation exchanges money for stock then someone also receives money in exchange for stock. It’s an asset swap.

  83. srini writes:

    “Dividends and the money used to purchase stock both came out of profits and hence are part of GDP.”

    Mark,

    You don’t know a jack about NIPA. Yet you speak confidently. Where in NIPA is purchase of stock recorded? So, if companies have moved increasingly toward buying back stock and away from paying dividend, less NIPA income will be recorded, which other things remaining the same will tend to depress the saving rate.

    There are several other problems with NIPA–capital gains taxes are recorded but not capital gains, treatment of defined benefit, and many others.

    In general, if the wealthy are finding ways to accrue more income in the form of capital gains (eg. carried interest), the NIPA income and saving rate will tend to be depressed. You cannot draw the conclusions you do from the NIPA saving rate.

  84. stone writes:

    Mark A Sadowski@82 “If a corporation exchanges money for stock then someone also receives money in exchange for stock. It’s an asset swap.”

    BUT that is also true whenever an individual saver buys stock. Same thing if she or her asset manager chooses to buy treasury bonds (in the secondary market) or gold bullion or foreign currency or anything that isn’t directly accepted as medium of exchange in her country. They are all simply “an asset swap”.

    What DOES count as saving under your hyper-restrictive definition? It seems limited to paying off debts and putting legal tender in your pocket. I can now see how you are coming to the conclusion that it is only pennyless debt-peons that save.

    The thing is though, those “asset swaps”, as you call them, that occur because the rich are “not dissaving” (as you insist it is termed) ARE what gives the underlying phenomenon that this is all about. As the rich gather together ownership of more assets, more and more of the cash flow from the economy gets directed to bidding up an ever more restricted subset of the economy’s pool of assets. Basically buying assets is the only use for money that someone like “person A” in the example@57 above has.

    You say that when money is used to buy a pre-existing asset, then that money just gets passed on to the previous owner. BUT the whole point is that the previous owner is now more than likely also a member of the “never to dissave” class. Once the profits from the economy enter the realm of being passed to and fro in asset swaps conducted on the behalf of ultra-rich people who never dissave, then that money might as well have entered a black hole.

  85. […] Standards of evidence – “Now let’s be perfectly clear: there is no reliable quantitative relationship between inequality and growth, just as there is no reliable quantitative relationship between taxation and growth, between government spending and growth, monetary policy and growth, or pretty much anything else and growth.“ […]

  86. Mark A. Sadowski writes:

    srini,
    “Where in NIPA is purchase of stock recorded? So, if companies have moved increasingly toward buying back stock and away from paying dividend, less NIPA income will be recorded, which other things remaining the same will tend to depress the saving rate.”

    Share repurchase is an asset transfer. The money received in exchange for share repurchase does not count as personal income because shares are exchanged in return for the payment. It is not income derived from the production of new goods and services.

    “There are several other problems with NIPA–capital gains taxes are recorded but not capital gains, treatment of defined benefit, and many others.”

    Capital gains and payments from pension plans are also asset transactions and consequently are not income derived from the production of new goods and services.

    “In general, if the wealthy are finding ways to accrue more income in the form of capital gains (eg. carried interest), the NIPA income and saving rate will tend to be depressed.”

    Tax law has little to no effect on how income derived from the production of new goods and services is counted under NIPA (or SNA).

  87. […] See full story on interfluidity.com […]

  88. srini writes:

    Mark,

    I quoted what you wrote, which is “Dividends and the money used to purchase stock both came out of profits and hence are part of GDP.” And then when i ask you where in NIPA is stock purchases recoreded and you give me lecture on accounting? Dont talk down you dimwit. I work with the NIPA everyday–I have forgotten more about the NIPA than you have ever learned.

    Tax law has no effect on income derived from production??? How do you make that assertion without addressing some of the points I made?

    You have some arrogance for someone so ill-informed.

  89. Mark A. Sadowski writes:

    stone,
    “They are all simply “an asset swap”.”

    That is correct.

    “What DOES count as saving under your hyper-restrictive definition?”

    Under NIPA and SNA personal savings is the difference between current (as opposed to capital) receipts and disbursements. More specifically, in NIPA terms, it is personal income less personal consumption, personal income taxes and interest paid to businesses.

    “The thing is though, those “asset swaps”, as you call them, that occur because the rich are “not dissaving” (as you insist it is termed) ARE what gives the underlying phenomenon that this is all about.”

    The word “dissaving” occurs repeatedly in Carroll (1998).

    “As the rich gather together ownership of more assets, more and more of the cash flow from the economy gets directed to bidding up an ever more restricted subset of the economy’s pool of assets.”

    By “cash flow” I presume that you mean the value of transactions taking place in a given period of time. From the standpoint of underconsumption theory “cash flow” is not relevant. Only income that is derived from the production of new goods and services is.

  90. Mark A. Sadowski writes:

    srini,
    “Tax law has no effect on income derived from production???”

    Tax law has little to no effect on how income derived from the production of new goods and services is *counted* under NIPA (or SNA).

    “How do you make that assertion without addressing some of the points I made?”

    Your point is that money received from asset transactions is not considered income under NIPA. But that is because it is not income derived from the production of new goods and services.

  91. stone writes:

    Mark A. Sadowski

    Lets imagine a very simple example to try and drill down what is the sticking point in our mutual incomprehension of each others view of this.

    Firm makes 100 widgets at a cost of $2 each, paying staff $1 and material supplier $1.
    Firm sells those widgets for $3 each and uses the $100 profit to buyback its stock.
    The billionaire share owners see all of the profits translate into appreciation of their wealth but they get no income and never intend to dissave -just as in the Carroll paper; their “capitalist spirit” is so strong that it overwhelms any desire to blow the money on some risky tech venture or fund a libertarian think tank or whatever.

    So I would say that $100 of saving has occurred and that that saving has been conducted on behalf of the billionaire share owners.

    I’m really not clear in my mind whether you are saying that no saving has occurred or that saving has occurred but that it is disconnected from the shareholders.

    However you characterize it, to my mind, this dynamic is heading for trouble because there is “leakage to savings” and so people such as the staff and the material suppliers won’t have the funds to buy widgets so how can the share holders hope to still take profits when the profits are permanently sequestered into accumulations of wealth in this way (saved as I would call it). Do you disagree?

    Note- I would have an utterly different view if the $100 of profit was spent on improving the machines of the widget factory. Then the profits would be back circulating in the real economy. The makers of those machines would get the funds to become potential widget buyers etc etc. The widget factory with modern machines might then have higher earnings such that the shareholders got capital appreciation in a sustainable manner. BUT rational shareholders won’t risk that if there is a dwindling number of customers able to pay for widgets.

    That’s what I understand by the whole underconsumption idea. I understand that you consider it wrong but I’m getting seemingly contradictory reasons as to how it is wrong.

  92. Mark A. Sadowski writes:

    stone,
    “So I would say that $100 of saving has occurred and that that saving has been conducted on behalf of the billionaire share owners.”

    An asset transfer has occurred. The corporation has $100 less in cash and owes $100 less in financial liabilities. The individual who sold the shares has $100 more in cash and $100 less in financial assets. No savings out of income derived from the production of new goods and services has occurred.

    “Do you disagree?”

    I do not believe that savings out of income derived from the production of new goods and services is responsible for the increasing inequality in the distribution of wealth. I do believe that excessive inequality in the distribution of wealth can have negative economic and social consequences. Thus it is all more important that we correctly identify what are its causes.

  93. stone writes:

    Mark A Sadowski@92 Don’t you see that the non-dissaving shareholders now are each the beneficial owners of a larger proportion of the profit stream? Isn’t that a wealth ballooning feedback loop?

  94. Mark A. Sadowski writes:

    stone,
    “Don’t you see that the non-dissaving shareholders now are each the beneficial owners of a larger proportion of the profit stream?”

    The shareholders that didn’t sell their shares are now each the owners of a larger proportion of a corporation that has a lower net worth. Furthermore, if the shareholders that didn’t sell their shares are better off because of the share repurchase, this necessarily implies that the shareholders that sold their shares are worse off. If this is always the case why would anyone ever sell their shares in share repurchase?

  95. stone writes:

    Mark A Sadowski@94
    “The shareholders that didn’t sell their shares are now each the owners of a larger proportion of a corporation that has a lower net worth.”

    The net worth of the company after the buyback is the same as it was before the $100 profit was made from selling the widgets. Each of the remaining shareholders is now wealthier than they were before the widgets were made. Furthermore, in the next period, they will get even more profits each. They are benefiting from compounding returns.

    “if the shareholders that didn’t sell their shares are better off because of the share repurchase, this necessarily implies that the shareholders that sold their shares are worse off. If this is always the case why would anyone ever sell their shares in share repurchase?”

    You are now off on a tangent wondering about how evenly share buybacks distribute profits. Fact is they do dish out profits to shareholders. In principle every market exchange is at a price that the market has discovered where it is equally sensible either to buy or to sell. If markets were perfectly liquid and the share buybacks had no price impact, then the only change would be increased earnings per share for the remaining shareholders. Off course that isn’t the case so they do push the price around and benefit astute active traders more than buy-and-hold owners. I’m sure our hypothetical billionaire shareholders have creme de la creme strategies to recoup the $100 profit very efficiently. The churn between different shareholders is all part of that process. Even if we were for the sake of argument in some fantasy world of perfectly liquid markets, shareholders would still sell up simply because they wanted more of one stock (or other asset class) and less of another. Imagine they were wanting to hold a market cap weighted index. If our widget maker now has fewer shares in circulation and the same market cap, the cap weighted index will now need fewer of those shares.
    The overriding point though is that the profits stay with the “never to dissave” class. The shareholders who do sell up are not dissaving, they are just portfolio re-balancing. The profits have leaked out away from the real economy and will never again be available to potential widget buyers.

    I’m beginning to wonder whether you are just stringing this along for a joke. I’m gullible and easy prey to that because I do really care about this and I also know your viewpoint is widely held even though I have failed to comprehend it.

  96. Mark A. Sadowski writes:

    stone,
    “The net worth of the company after the buyback is the same as it was before the $100 profit was made from selling the widgets.”

    The net worth of the corporation is less immediately after the share repurchase compared to its net worth immediately before the share repurchase.

    “…and I also know your viewpoint is widely held even though I have failed to comprehend it.”

    Well, according to the Modigliani–Miller theorem, also known as the capital structure irrelevance principle, under certain somewhat unrealistic assumptions the value of a corporation is completely unaffected by how it is financed. It does not matter if the corporation’s capital is changed by the issuing or repurchasing of stock, by the selling or retiring of debt, and it does not matter what the corporation’s dividend policy is.

    In reality capital markets are subject to imperfections so a share repurchase very likely will result in winners and losers. But it seems to me that this is as likely to go one way as the other. There is no way to know a priori that it is the share holders that do not sell who will benefit from a share repurchase.

  97. stone writes:

    Mark A Sadowski@96, I’m just trying to say that the company making a profit makes the share owners wealthier by the amount of that profit. Do you really not accept that?

  98. Mark A. Sadowski writes:

    stone,
    “I’m just trying to say that the company making a profit makes the share owners wealthier by the amount of that profit. Do you really not accept that?”

    Theoretically and empirically there is a relationship between corporate earnings and the price of a share. But there is no one-for-one correspondence between corporate profits and changes in the value of shares. One is a measure of income and the other a measure of financial wealth.

  99. stone writes:

    Mark A Sadowski, just to clarify, what I care about is the reality of secular stagnation induced by wealth inequality and the fact that denying it is now so widespread and respectable.

    It’s something that has been apparent since money existed and has been written about since writing existed. Basically it comes about when this:

    “Money bearing compound interest increases at first slowly. But, the rate of increase being
    continually accelerated, it becomes in some time so rapid, as to mock all the powers of the
    imagination. One penny, put out at our Saviour’s birth at 5% compound interest, would,
    before this time have increased to a greater sum than would be obtained in a 150 millions of
    Earths, all solid gold. ” (Richard price 1772)

    gets brought down to earth by this:

    “It is utterly impossible, as this country has demonstrated again and again, for the rich to save as much as they have been trying to save, and save anything that is worth saving. They can save idle factories and useless railroad coaches; they can save empty office buildings and closed banks; they can save paper evidences of foreign loans; but as a class they can not save anything that is worth saving, above and beyond the amount that is made profitable by the increase of consumer buying. It is for the interests of the well to do – to protect them from the results of their own folly – that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit. This is not “soaking the rich”; it is saving the rich. Incidentally, it is the only way to assure them the serenity and security which they do not have at the present moment.” (quoted by Marriner Eccles 1933)

  100. stone writes:

    Mark A Sadowski@98: “Theoretically and empirically there is a relationship between corporate earnings and the price of a share. But there is no one-for-one correspondence between corporate profits and changes in the value of shares. One is a measure of income and the other a measure of financial wealth.”

    We don’t need a neat one-for-one relationship in order to establish that your whole argument is baseless. All we need is a directional trend.

  101. Mark A. Sadowski writes:

    stone,
    To restate, in underconsumption theory recessions and stagnation arise due to inadequate consumer demand relative to the level needed to attain the potential GDP of new goods and services. Consequently it is the income that is derived from the production of new goods and services that is connected to the matter of whether underconsumption is actually taking place. But there is no empirical evidence in the US today that those with high incomes are saving a disproportionate amount out of the income they derive from the production of new goods and services.

    That being said, I believe there is empirical evidence that inadequate aggregate demand can have negative consequences for aggregate supply. I also don’t think there is any doubt wealth inequality is at or near an all time high in the US and this may have serious negative economic and social consequences. Thus it is all more important that we correctly identify what are the causes of each.

  102. stone writes:

    Mark A Sadowski, I’ve tried my hardest to explain why I view as irrelevant your straw man:

    “But there is no empirical evidence in the US today that those with high incomes are saving a disproportionate amount out of the income they derive from the production of new goods and services.”

    I’ve tried my hardest to explain that what is relevant IMO is the saving of PROFITS.
    http://en.wikipedia.org/wiki/Michał_Kalecki#The_profit_equation
    http://www.levyforecast.com/assets/Profits.pdf

  103. Mark A. Sadowski writes:

    stone,
    The corporate net lending is not identical to corporate profits. Furthermore, although corporations have had a positive financial balance since the recession, this is not typical. Since 1960 on average corporate net lending has been almost exactly 0.0% of GDP:

    http://research.stlouisfed.org/fred2/graph/?graph_id=151315&category_id=0

  104. stone writes:

    Mark@103 sorry but what’s corporate net lending got to do with this?

  105. Mark A. Sadowski writes:

    stone,
    “sorry but what’s corporate net lending got to do with this?”

    The Kalecki Profit Equation states that business sector profits are equal to business sector investment minus household sector net lending minus government sector net lending minus foreign net lending.

    Net lending is closely related to savings. Profits are not.

  106. stone writes:

    Mark A Sadowski@105, “Net lending is closely related to savings. Profits are not.”

    Lending does not come from saving though does it -its just credit expansion. check out for instance http://www.boeckler.de/pdf/p_imk_wp_100_2012.pdf

    To me, the whole point of both of those two links @103 is that profits either come from spending of previous profits -which is something that can continue indefinitely, or from credit expansion -which is something that sooner or later runs into trouble.

  107. Mark A. Sadowski writes:

    stone,
    “Lending does not come from saving…”

    To be excruciatingly clear, “net lending” is a very similar concept to “savings”. In particular, there is no such thing per se as corporate savings. Corporate “net lending” is the closest analogue.

  108. rsj writes:

    Mark,

    So you are saying that if someone zeroed your bank account, then this would not affect your consumption at all? After all, your income out of the production of newly produced goods and services is zero, right?

    Similarly, if the government borrowed an extra trillion and distributed it as a benefit payment to everyone, then no one’s spending will be changed, because their income out the production of newly produced goods and services is unchanged as well?

    Again, if you want to conclude Ricardian equivalence or that the loss to one family is exactly offset by the gain to another, that is something that you need to prove by solving the optimization problem for a lot of households and then aggregating across households to determine whether there are any macro effects of the above operations.

    But if you build these equivalence assumptions into your definition of income, and into the definition of what goes into the value function of each individual household, then I don’t see how you can even join the conversation about asset bubbles and inequality. It seems you are just assuming everything way in your own idiosyncratic definition of household income, whereas real households care very much about declines or increases in the value of their land holdings.

    Moreover, there is a wealth of observational data proving you wrong — that households care very much about changes to the value of their land holdings and adjust their spending considerably as a result. They would be fools not to, because this is an important determinant of their quality of life, particularly when they retire. Any theory that even pretends to be founded on micro behavior should take this into effect.

  109. Detroit Dan writes:

    SRW– One of your best posts ever! Brilliant.

  110. stone writes:

    Mark@107, I was a bit disoriented by your @105 comment and I think I failed to grasp your point. Sorry if I’m stating the obvious or still not grasping it but my impression is that in the lead up to 2008, profits were ultimately largely coming from expansion of mortgage debt. There wasn’t “net lending” by the corporate sector because they were selling MBS back to households and to foreigners. So overall, middle class people became increasingly indebted to the wealthier households and foreigners who held MBS. Then that all came unstuck in 2008 and today the record level of profits comes from government deficit spending.
    http://www.businessinsider.com/goldmans-jan-hatzius-on-sectoral-balances-2012-12

    To put this in the context of the widget makers (in @91 above), – prior to 2008 they managed to continue to sell widgets for a profit because the workers all re-mortgaged their houses and used the money to buy widgets. When the profits were used to buyback stock, the shareholders who sold accumulated MBS. Then in 2008 it became apparent that the workers couldn’t pay off the mortgages because they had spent the money on widgets -so the government bailed out the MBS. Now the system runs on the government buying widgets and also paying staff foodstamps so that the staff can buy widgets.

  111. […] side, I guess I couldn’t ask for a better example of the phenomenon I described in “Standards of Evidence” than this piece by Ezra […]

  112. Mark A. Sadowski writes:

    rsj,
    “So you are saying that if someone zeroed your bank account, then this would not affect your consumption at all? After all, your income out of the production of newly produced goods and services is zero, right?”

    It would depend greatly on what caused the account to become zeroed.

    “Similarly, if the government borrowed an extra trillion and distributed it as a benefit payment to everyone, then no one’s spending will be changed, because their income out the production of newly produced goods and services is unchanged as well?”

    No, that would constitute fiscal stimulus, and assuming the central bank did not offset it because of the targets it is pursuing, a fiscal stimulus would raise aggregate demand. By definition higher aggregate demand would mean higher nominal incomes and spending. Higher nominal incomes would mean desired savings would fall but higher nominal spending would mean desired lending would rise. Consequently overall savings would probably increase. In fact aggregate demand was so low in 1932-33 during the depths of the Great Depression that the personal savings rate was negative.

    “Again, if you want to conclude Ricardian equivalence or that the loss to one family is exactly offset by the gain to another, that is something that you need to prove by solving the optimization problem for a lot of households and then aggregating across households to determine whether there are any macro effects of the above operations.”

    You’re missing the point. Obviously I think considering the behavior of different kinds of households to be important because I brought in empirical evidence in my first comment on the savings behavior of households by income level. But it is precisely because we are interested in the effects of this behavior on the production of new goods and services that we need to focus on savings relative to the income derived from the production of new goods and services.

    “But if you build these equivalence assumptions into your definition of income, and into the definition of what goes into the value function of each individual household, then I don’t see how you can even join the conversation about asset bubbles and inequality.”

    It is not impossible to build a fully microfounded model of savings out of the income derived from new goods and services that takes into account households’ evaluation of wealth. The problem however is that in order for it to be macro model it must model a macro definition of savings, otherwise it is irrelevant.

  113. Mark A. Sadowski writes:

    stone,
    “Sorry if I’m stating the obvious or still not grasping it but my impression is that in the lead up to 2008, profits were ultimately largely coming from expansion of mortgage debt. There wasn’t “net lending” by the corporate sector because they were selling MBS back to households and to foreigners.”

    This part makes sense because financial sector profits were healthy during 2000-06 and the financial sector as a rule rarely runs a large financial balance one way or the other. They are intermediators.

    “So overall, middle class people became increasingly indebted to the wealthier households and foreigners who held MBS.”

    The 2000-06 period is actually the only period since 1980 that the household sector has consistently run a primary deficit. See this excellent paper coauthored by J.W. Mason for example:

    http://repec.umb.edu/RePEc/files/FisherDynamics.pdf

    I’ve attempted to disaggregate household sector debt dynamics by income level over the entire period of 1980-2006 and it implies to me that the primary reason why leverage increased at lower income levels relative to higher income levels isn’t their differing borrowing rates but the dramatic increase in real effective interest rates and the decline in the growth rate of nominal incomes after 1980. Much of this increase occured in nominal effective interest rate is attributable to financial deregulation, with tight monetary policy playing an ancilliary role through lower inflation rates and the decreased growth rate in nominal incomes. When you combine this with differing initial debt leverage by income level you get this enormous divergence in changes in leverage by income level.

    In short, when one looks at the entire period from 1980 to 2006, the relative changes in leverage by income level had almost nothing to do with differing primary deficits by income level.

    “Then that all came unstuck in 2008 and today the record level of profits comes from government deficit spending.”

    The Kalecki Profit Equation is an accounting identity. One should be careful about causal explanations when referring to it.

  114. stone writes:

    Mark A. Sadowsk@112 “The problem however is that in order for it to be macro model it must model a macro definition of savings, otherwise it is irrelevant.”

    To me the general issue of wealth gathering more wealth leading to the phenomenon Steve’s post is about (and that is illustrated in the quotes @99) is only beholden to what is really happening in the economy. If your “macro definition of savings” fails to get to grips with it then IMO that is a failing on your part. Perhaps what it means is that in order to understand what is happening you’ll need to adopt a more perceptive view of what is really going on.

    Thanks for the link @113 by the way.

  115. errorr writes:

    I hate to wade into this but is stone making more of a velocity argument tangential to the underconsumption hypothesis?

    It would be more likely that to be that if savings is uneffected by inequality one could surmise that velocity decreases under more unequal distribution of income.

    I almost want to write something that says NGDP targeting would effectively sidestep the moral necessity of redistribution.

    The age structure of the economy seems just a critical for desired savings.

  116. stone writes:

    errorr @115, “I almost want to write something that says NGDP targeting would effectively sidestep the moral necessity of redistribution.”

    One problem though is that NGDP targeting by QE might well not succeed in raising NGDP in a constructive way if at all. I had a go grappling with that issue in a post myself http://directeconomicdemocracy.wordpress.com/2013/11/17/monetary-policy-inflation-expectations-the-1930s-and-now/

  117. stone writes:

    Mark A Sadowski @113, I totally agree with the description that a big factor behind middle class people becoming indebted was the falling inflation during the 1980-2008 period, causing mortgage debt to not be inflated away anything like as much as might have been expected from a 1979 vantage point.

    The reason why I don’t think any of this undermines the “underconsumption hypothesis” is because I don’t think that the underconsumption hypothesis is in anyway based on differences in NIPA income saving rates between people with high income and people with low income. Instead the underconsumption hypothesis is based on lower consumption relative to WEALTH by the wealthy as compared to the poor.

    As I said, if your framework of macroeconomics isn’t up to the job of grasping that then IMO you need to go back to the drawing board and fix your framework. Remember we are talking about a phenomenon that has been written about continuously for thousands of years before NIPA accounting conventions were chosen. If dispersal of profits by share repurchases or mergers and aquisitions or firms buying stock of other firms (as done by Berkshire Hathaway) are all missed by NIPA income, then all that means is that the convenience of using NIPA data is a convenience that can’t be afforded if we want to understand reality.

    As an analogy, imagine you were an astronomer and you generally worked using data that was posted on the internet by the Hubble space telescope or whatever. Some critical aspect of cosmology was only perceptible at part of the light spectrum not collected by that telescope. To do a decent job, you would have to just forgo the convenience of relying on your usual data set and instead look wider. It would be goofy to say that anything that wasn’t part of the Hubble data stream was irrelevant to astronomy. Astronomy is about the universe and not about that data stream. Likewise macroeconomics is about the economy and not about the NIPA datastream.

  118. stone writes:

    Mark A Sadowski, let’s consider that previous example with person A and person B (@57 above). Let’s imagine that neither person take much note of what is going on behind their personal finances. All they do check total available funds each month.

    Person A sees her total available funds increase (roughly and erratically) by say $92M when she checks them each month and so is relaxed about her bills of $83k each month.

    Person B sees total funds increase by $1.7k when she checks them each month and so is relaxed about her bills of $1.5k each month.

    A and B are sisters and stop by for a chat. Person B accuses person A of being feckless and not saving. Person A is astounded and says that her outgoings amount to less than 0.01% of the amount her account increases by each month. Person B says that B’s account has been increasing in a way that is not classed as income by NIPA. Person A says “who gives a flying expletive”. How would you explain the relevance of the distinction?

  119. stone writes:

    sorry my typo in @118,

    it should be “….to less than 0.1% of the amount…..”

  120. Mark A. Sadowski writes:

    stone,
    Your last series of comments are even more irrelevant, strange and insulting than your previous comments. Consequently I don’t see anything productive coming out of this conversation at all this point. Many economists think the evidence for the underconsumption hypothesis is very weak, and yet still think inequality is an important issue worth thinking about, among them Paul Krugman:

    http://krugman.blogs.nytimes.com/2013/01/20/inequality-and-recovery/

  121. stone writes:

    Mark, sorry if you found what I said insulting. I didn’t mean it to be. I still don’t understand your viewpoint that the underconsumption hypothesis hinges on differences in consumption in relation to NIPA income. I also failed to communicate my view to you. Let’s not add ill feeling to a communication failure.

  122. stone writes:

    Mark, I just re-read that Krugman piece you linked to (it is a while since I last read it). Like you say, he is making exactly the same argument as you. So, as you say, your argument is worthy of Nobel Prize winners but it is still mistaken in my view for the reasons I said to you and I would say to him too :) .

  123. […] Esta reciente entrada de Steve Randy Waldman me resulta… incómoda. Su argumento, que los economistas infravaloran la aportación al crecimiento de las políticas redistributivas porque […]