Monday, August 23, 2010

The 5 new normals

Fortune magazine published an article addressing permanent changes likely to occur following the Great Recession. You can view the article here.

We have already discussed the likely causes of higher long-term unemployment and higher taxes for the wealthy. The article also mentions saving over spending. Households have shifted from consumption to saving. Over the last decade US households relied on asset price appreciation for accumulating wealth. Houses became ATMs. Households stopped saving money. We used the stock market and homes to buy an excessive amount of goods. These spending levels contributed to record trade deficits and debt levels. Following the housing crash, most families saw their retirements shrink and housing equity disappear. Additionally it has become more difficult to obtain credit for major purchases.

We are seeing the paradox of thrift. As households respond to the economic downturn by saving more, consumption will decrease. Subsequently, GDP will decrease. In the short run added saving will hurt our recovery effort, but I believe added saving will greatly improve our countries fundamental positions. Added domestic saving we help offset government deficits and the need for foreign funding. Added saving levels will help keep interest rates low in the long run. Later in the term we will look at some of my research that looks at the relationship between domestic saving rates, economic growth, and business cycle volatility. I would rather see the government focus on policies that promote added domestic saving levels. This is something we will continue to discuss throughout the term. Here is a picture of current domestic saving levels. As you can see, domestic saving rates have steady decreased from 1980-2007.

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