While there is no doubt that the current recession is fundamentally linked to excesses in financial markets and asset prices, there were still some classic macroeconomic imbalances that preceded the crisis. For years we have been talking about global imbalances and how certain advanced economies (the US in particular) were building large deficits. A current account deficit is simply a measure of the difference between spending and income for a country. The source of spending can be many (government, companies – in the form of investment- or consumers). In the case of the US, consumption grew to levels that we had never seen before. The chart below displays household consumption as a ratio to GDP for the US and four other advanced economies.
This is a ratio that we expect to be fairly constant for a country with stable growth rates (as it is the case for these economies). In fact, in the cases of Germany, France and Japan, consumption remains fairly stable during the sample, as we expect. It is true that in the case of Japan we see the ratio increasing in the 70s but this has an explanation: as convergence in living standards materializes, the country’s saving rate goes down from the very high rates of previous decades; rates that were needed to sustain the very high growth rates of Japan in the 50s and 60s.
The US, and to a much smaller extent the UK, have seen consumption increasing at rates much faster than GDP for the last two decades. In the case of the US the ratio reached a peak of almost 72% in 2007. How could this trend be justified? For this number to go up, a combination of these things should happen:
- Lower taxes (current or future) that increase disposable income
- Expectations of larger future income (through faster productivity growth
- Related to the previous one, expectations of more productive investment which reduces the need to save and invest to generate the same amount of future income
- A demographic transition that makes the future (income or wealth) look “better” than the present.
While one can always debate about whether some of these assumptions were reasonable during the last decades, overall one finds more arguments that go in the opposite direction and might have justified a lower consumption rate. An aging population and a growing government debt make the future look worse than the present. If any, there is the need to increase saving (i.e. reduce consumption). In terms of productivity growth while the 90s looked good, there is no consistent signal that productivity growth is accelerating dramatically in the US or UK economies.
How can it be that in the light of such strong evidence of a macroeconomic imbalance very little was done about it? During those years asset and housing prices were booming and this was used as a justification for the consumption increase: as a ratio to wealth (not income or GDP), consumption was not growing that fast. Of course, for this to be true those asset prices had to be sustainable and this could only happen if one of the arguments above was true (for housing prices to remain as strong as they were before the current crisis one had to assume very high future demand for houses because of large income or population increases).
Today’s perspective is, of course, very different as asset prices have collapsed and consumption looks also very high relative to wealth; it is clear that these imbalances need to be addressed. Unfortunately, this is the wrong time to address such an imbalance. In the middle of a deep recession, economic policies work to stimulate consumption, not depress it. If consumers starts saving now they will make the recession even worse and this will reduce income and wealth even further, a recipe to make the adjustment even more difficult. No surprise that policy makers, such as Larry Summers today in an interview with the FT, are making the arguments that this is not the time to save. Point taken but let’s make sure that when we are out of the recession we look back at this chart and make a conscious decision to avoid these growing imbalances reappear again in the future.
Antonio Fatás
