Wednesday, June 2, 2010

As Governments Borrow, Many People Save

Copyright, The New York Times Company

Government deficits have stabilized in recent months, and so has private savings. It is likely that the private sector dampens the effects of government borrowing.

By definition, the government runs a deficit when its spending exceeds its revenue. It typically finances the difference by borrowing. Of course, future governments are burdened with paying the principal and interest on the government debt created today, which is why many critics of deficit spending conclude that such deficits leave us worse off in the future.

Before the recession, which officially began at the end of 2007, the amount of government dissaving (combined for federal, state and local governments) was about zero. Thanks in large part to federal government actions, quarterly public dissaving increased to $400 per person in the first two quarters of the recession and by an additional $400 per person in the first two quarters of 2009. Since then, public dissaving has stabilized at $700 to $800 per person.

National savings — the sum of public and private savings — is ultimately what matters in shaping living standards in the future; the government deficit matters only to the extent that is affects national
savings. To the degree that private saving offsets public dissaving, public dissaving leaves no negative legacy.

The chart below graphs public dissaving versus private saving, both measured by the Bureau of Economic Analysis and expressed in inflation-adjusted dollars per person for each of the 10 quarters since the end of 2007.

The more recent points are furthest to the right in the chart, because of the historically large government deficits. But they are also at the top of the chart, because the private savings rate has been unusually high. In fact, the chart shows a strong positive correlation between the amount of public dissaving and the amount of private savings.

Earlier this year, I blogged about Prof. Robert Barro’s theory that the private sector responds to public borrowing by saving, because the private sector anticipates that its taxes will be higher in the future in order to service today’s public debt.

Readers, and many economists, were dubious that private savers think about future taxes or give them much importance in their saving decisions. But the association of more public dissaving with more private saving continues to be confirmed with data from recent quarters, so that correlation needs to be explained.

I also pointed out that the private sector seems to love government debt, as evidenced by the fact that government debt sells in the marketplace for such high prices (that is, investors accept such low rates of interest when the federal government borrows). Thus, another possible explanation for the pattern shown in the chart is that a surge in private saving pushes down government bond yields and encourages the government to borrow more.

A related explanation is that both the private and public sectors are reacting to the recession, with the public sector borrowing and the private sector saving.

That the private sector would save, rather than borrow, in a recession seems odd, especially later in the recession when employment and incomes reached their lows. Yet it seems they do.

Thus, regardless of whether government borrowing harms or helps the economy, the effects of government borrowing are dampened, if not largely offset, by private sector responses.

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