Arnold Kling  

Supply-side Dissatisfaction, II

Trade War?... World Population Outlook...

N. Gregory Mankiw, incoming chairman of the President's Council of Economic Advisers, continues to take flak from supply-siders. In this essay, I discuss the latest attack, from The Wall Street Journal's Susan Lee (subscription required).

Her objection to Mankiw is current. She complains that "his best-selling textbook argues that deficits or government debt pushes up interest rates."

I raise a concern with the "Ricardian equivalence" theory.

I do not know anyone who makes their savings decisions by looking up the government Budget data. So you have to argue that somehow people are factoring in the government Budget implicitly without being aware of it. Although as an economist I believe that people can solve complex optimization problems intuitively if they have enough practice, there is no way for people to "practice" making long-term saving decisions--you only go around once in life.

For Discussion. Are there mechanisms that I am missing that make Ricardian equivalence more plausible?

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CATEGORIES: Supply-side Economics

COMMENTS (3 to date)
randy writes:

I think what you may be missing is that, while people may not be perfect optimizers, they are not stupid either. There are lots of mistakes I don't make because I have learned from other's experiences - even though I have not personally made that mistake. Also, if the media makes a big enough stink about it (error-prone as their analysis might be), people will sit up and take notice. My gut feeling is that the bigger the impact, the more likely the public will get it. When I have taken surveys of my students, or discussed the issues in class, usually the students display at least rudimentary forward-looking behavior. Furthermore, we are talking about aggregate consumption, which is driven by the relatively well-to-do - who might be getting, one way or another, better advice regarding lifetime planning. (Also, the elderly, and those with few kids, have less incentive to save up for future taxes ...)
I think the bigger issue might have to do with the role expectations play. The public might expect that, several years from now, government spending will be reigned in. In this case, the impact on lifetime income is slight. This is not entirely unreasonable ... but obviously in this scenario, interest rates do rise.

Scott writes:

Perhaps people do make savings decisions based on long term government deficits. Go talk to financial planners. Their clients almost all make the assumption that social security will not be available to them when they retire. Hence, to maintain their standard of living in retirement, they save more now.

I don’t know whether this savings behavior is due to government deficits, the structure of social security, or changing demographics. Whatever the cause, it seems to be happening.

rvman writes:

I like the social security angle. Also, I haven't looked at the numbers, but a vector through consumer confidence may be possible. (High deficits create uncertainty, which results in lower confidence, which results in higher private savings rates.) I think the third argument in the list in the essay makes more sense. Even a 2 trillion dollar increase is only 5% of the overall market - elasticity would have to be pretty big for that to make more than a 1 percentage point increase in interest rates. Yes, that would be fairly large, but not in context of the movements over the course of a business cycle.

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