Deficit spending :increased consumption or savings

Jan. 26, 2008 12:54 pm

Some of the critics of the stimulus package are claiming that the plan will simply transfer money to people who will use it to either pay down their private debts or increase their savings.

Many of these critics are the same people who claim that greater savings lead to greater investments and that America suffers from too little savings.

So which is it ?

You can't argue both of these positions simultaneously as they are contradictory.

If you believe as some neo-classical rational expectations economists do that savings automatically translate into greater investment in the private sector and therefore increasing them will increase investment and greater investment entails faster growth and greater job creation and you are arguing that the stimulus plan will substantially lead to higher savings or lesser private indebtedness than you must believe it to be stimulative.
Unless you believe that increased public dissavings, that is an increased deficit undermines this by causing interest rates to rise and chokes off investment through crowding out.but this won't happen if interest rates are kept low by the Fed.   Keynesians like myself believe in fact that greater savings , other things being equal, is accompanied by less consumption and less aggregate demand. In any case savings are a residual from income less consumption. that is Y=C+I; and Y=C+S. This is true in the Marshallian short period as opposed to the Robertsonian lagged period.
( See my paper on the theory of the business cycle   in Keynes , Hayek and Schumpeter: what do we know in the age of globalization?
  Presented in London to the society of Heterodox economists to the session on Austrian economics , July 7, 2001 London, UK for a discussion of Robertson's theories of saving.)

Furthermore savings and investments are usually made by different economic actors and greater savings can complicate and delay the process by which savings are converted into actual investments in the economy that produce jobs.

The stimulus package will increase   consumer spending to the extent consumers' confidence in their job security is not too harshly shocked by events and to the extent that consumers spend the money on domestically produced and processed output it will have a larger multiplier impact.

So long as the Fed keeps the real interest rate close to or briefly if necessary even slightly below the core inflation rate the combination of the fiscal stimulus and the monetary one will ensure no crowding out occurs as the economy rebuilds confidence and restores growth. To the extent there are leakages to foreign produced goods so long as thoser economies are fair trading partners of the US the stimulus will return in the longer run through increased demand for US exports also stimulated by the falling US dollar exchange rate.

To the extent recipients of the rebates spend them on retiring debt and increasing savings the impact will depend on what the lenders who have their debts repaid or the banks who receive the increase in deposits will do with the money. Eventually it will be channeled back into the economy through an increase in the banking asset base and greater investments as the economy recovers but the time lag will be greater.

The positive differential in income, delta Y, will simply be greater to the extent neither interest rates nor investment nor consumption is held constant or consumption or investment declines or the real rate of interest rises because of deflation moving faster than the Fed cuts the nominal rate.