When Americans Spend Less than their Income
In this New York Times screed by Nobel Laureate Paul Krugman that decries the refusal of Republican acting director of the Federal Housing Finance Agency Edward J. DeMarco to write down mortgage balances for underwater homeowners, this somewhat offhanded remark was offered up to explain how the U.S. economy is really supposed to work and what’s wrong with it at the current time.
Some background: many economists believe that the overhang of excess household debt, a legacy of the bubble years, is the biggest factor holding back economic recovery. Loosely speaking, excess debt has created a situation in which everyone is trying to spend less than their income. Since this is collectively impossible — my spending is your income, and your spending is my income — the result is a persistently depressed economy.
How should policy respond? One answer is government spending to support the economy while the private sector repairs its balance sheets…
Now, there is an argument to be made that debt needs to be written down in order for a more sustainable economic recovery to develop and, as a non-economist, I’m probably missing something here about spending and income as it relates to how economists think of these terms, but, to suggest that the fundamental problem in the U.S. economy today is that people are spending less than their income is just ludicrous.
The only way you spend all or more of your income is to take on debt, so, the natural response to having taken on too much debt in years past is to take some of your current income to pay down that debt and that’s what’s happening now - the bill has come due and we’re paying it.
Just when you thought that the conventional wisdom amongst some prominent economists that “aggregate demand is the only thing that matters” couldn’t get any more bizarre, it does.