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Savings and stimulus

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A few days ago, I went out to a restaurant for lunch with a friend from work. I haven't gone out for lunch for a few months - usually I get something and bring it back to the office - and it struck me that there were only perhaps half as many people in the restaurant as usual. My friend, who goes out for lunch much more frequently than I, said that was typical of the restaurants in that area.

Now, this isn't because of layoffs, not in that area. The parking structure near work is as full as ever. People aren't taking pay cuts. I'm sure they're not just skipping lunch. It seems they just don't want to spend money on a restaurant lunch any more when they can bring something from home.

So the question is, why?

I think the answer must have to do with savings. Until a year or two ago, people were seeing the value of their retirement accounts and other savings steadily increasing. They figured they had a buffer if something bad happened, so they felt free to spend money. The general macroeconomic rule of thumb is that people spend 1-2% of their wealth - including retirement accounts and other savings - per year.

With the recent precipitous stock market decline, many people have seen the values of their savings and retirement accounts cut in half. The result seems to be that they are cutting their discretionary expenses accordingly.

This brings us to the question of stimulating the economy.

The traditional view is that the best way of stimulating the economy is by directly stimulating spending - and indeed, the highly targeted stimulus in the wake of the World Trade Center attacks kept that downturn from becoming a full recession. In that view, encouraging savings is a bad idea when one is trying to prevent a recession.

In the current situation, though, that's not so clear. Peoples' retirement accounts didn't halve in value because people pulled half their savings out. Rather, the value halved because a small fraction of the savings was pulled out rather suddenly, which causes stock prices to fall disproportionately.

In that light, ideas like South Carolina wanting to use their stimulus funds to pay down state debt don't sound so bad. The more debt that's paid off, the less of a market there is for loans, the lower interest rates will be, and the more attractive stocks are as an alternative to interest bearing investments.

Personally, I would have preferred that the stimulus bill not have been passed in the first place; I'm of the opinion that the economy needs a recession, and the stimulus will just spread the pain out over a longer period of time. However, given that the bill did pass, I think paying down state debt may be a reasonable use of the funds, and certainly better than creating new spending programs that will only be inflationary later.

On South Carolina:
http://online.wsj.com/article/SB123759827524401409.html

In Utah, it's the legislature that doesn't like the strings attached:
http://www.forbes.com/feeds/ap/2009/03/20/ap6193554.html

Alaska and Texas also refusing some funds:
http://www.google.com/hostednews/ap/article/ALeqM5j_qYftLxkozZUF01FT28aWT_kFCQD971MFI80
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On March 21st, 2009 06:38 am (UTC), countertorque commented:
My anecdotal evidence matches yours. Traffic is just as bad in the morning, but restaurants are dead.

What is the basis of stating "a small fraction of the savings was pulled out, causing the stock prices to fall disproportionately?" Are you saying the market responded in a broken way to money being withdrawn? I thought the market responded how it always would if that portion of money was withdrawn. There's no relationship that says everyone has to sell half of their stocks to get the market to drop half of its value, is there?
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On March 21st, 2009 03:05 pm (UTC), harrock replied:
The word disproportionate is often used to connote "unreasonable" or something like that, but in this context, I think it had the neutral meaning.
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On March 21st, 2009 04:36 pm (UTC), psychohist replied:
Sorry, I did not mean to imply that the market responded in any abnormal way; yes, it responded as it always does. As harrock guesses, by "disproportionate" I merely meant "more than proportionally"; I'll try to edit to a better wording that doesn't imply something out of the ordinary is going on.

Mostly my point is that saving x dollars will cause many times more than x dollars of increase in total wealth, especially in a buyer's market like this, and thus that the common wisdom that one wants to stimulate spending to the exclusion of savings may be wrong.
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On March 22nd, 2009 03:49 am (UTC), enugent commented:
Does "wealth" include a house that's mostly not paid for? Or is the 1-2% discretionary spending? Because otherwise, it seems pretty low. I think we spend closer to 20-25% of our wealth each year (our yearly rent alone is probably more than 10% of our savings), but we don't own a house.
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On March 22nd, 2009 04:47 am (UTC), psychohist replied:
Wealth includes only equity in the house, but not the amount that's mortgaged. However, the 1-2% is the effect of wealth, and doesn't include the effect of income. That is, spending is some function of income plus 1-2% of wealth.

It's also an aggregate statistic, which may vary fairly widely among individuals.
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