When Americans Spend Less than their Income

By Tim on 08/03/2012 in Debt, Economy

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.

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7 Responses to When Americans Spend Less than their Income

  1. Susan August 3, 2012 at 8:59 AM #

    I belong to a foreclosure website. The amount of money people borrowed with no resources to pay back blows my mind. In So Ca a home with the real market value of $400K could have loans against it north of $1.2M. Most of the homes we have previewed to buy seldom have the money put back into the properties, yet the “homemoaner” has a newer vehicle in the driveway. Screw them. Unless you were responsible, a long term homeowner, who lost their job or have medical black swan, who didn’t go re-fi mad, you deserve a spanking, not debt reduction. We’re knee deep in these re-fi stats, and most people were irresponsible greedy a-holes. Krugman is out to lunch, imho.

    • Mike August 5, 2012 at 10:28 AM #

      I find it interesting that your focus is on the borrower, not the lender. There’s been plenty of irresponsibility to go around on both sides. Yet, interestingly, the greedy lenders all get bailed out and the greedy borrowers get screwed with the moral hazard argument. Isn’t there something wrong with that?

      • DCX2 August 6, 2012 at 10:02 AM #

        Agreed. It’s not like the borrower has the lender at gun point, “give me a re-fi or you’ll regret it”. The lender made the choice to loan $1.2M on a $400k house. The lender made the choice to re-fi.

        Being mad at borrowers for being loaned money by lenders who didn’t do their job reminds me of parents who are upset that their kid is fat when it is the parents buying all the junk food.

  2. Dave Cohen August 3, 2012 at 9:33 AM #

    Tim,

    You said “I’m probably missing something here about spending and income as it relates to how economists think of these terms”

    Take from me, Tim, another non-economist (and thankful for it!) — you are not missing anything.

    best,

    - Dave

    • Tim August 3, 2012 at 10:57 AM #

      Yeak, I was half joking there, but there may be something about how the terms spending and income were used in this context that means something different to economists, making this less nuts than it would appear.

  3. Andrew August 3, 2012 at 11:39 AM #

    Because what we have currently going on is working so well? Take a look at Europe with their austerity measures. How is that working for them?

    The banks were freed of their “overhang” and they seem to be recovering. Give the people the same relief and we will be off to the races. No demand, no jobs. Jobs are the result of demand not the other way around in my humble opinion.

  4. Frank H August 5, 2012 at 8:29 AM #

    As Ricardo said in 1821…”men err in their production, there is no deficiency of demand”. The classical economist would be turning in their graves if they saw how the economic science has regressed since Keynes! All this talk of demand, when the classical economist actually understood that it was supply not demand that is the problem (Say’s law) When the village idiot, aka..Krugman, is the most influential economist on the planet we are in deep trouble..