"They'll Just Save It."
How many times have you heard the following argument in the last two years?
Tax cuts/helicopter drops of cash/whatever won’t stimulate demand. People are too nervous to spend. Whatever you give them, they’ll just save it.
The problem with this claim, like the analogous argument about reserves, is that it never considers the savers’ motives. Why are they saving in the first place? Once again, there are two theories:
Theory #1: People just don’t have anything they want to buy. They’re satiated, so no matter how much extra income they get, they’ll just sit on it.
Theory #2: People want a buffer. They aren’t comfortable with their current asset cushion, so they’re saving in order to return to their comfort zone.
Theory #1 is wholely implausible. There’s tons of stuff that people still covet. The truth, then, lies in Theory #2: People will start spending again once they feel like they’ve got enough breathing room.
So what? Well, if you believe in Theory #2, tax cuts/helicopter drops of cash/whatever do much more to stimulate demand than they appear. Even if they don’t persuade anyone to actually spend more, they move people closer to their financial comfort zone. And once they reach that zone, they’ll start spending again! Even seemingly ineffective efforts to boost demand reduce the time we’ll have to wait before demand begins to rise.
If your goal is to stimulate demand, then, the right implication to draw from the “They’ll just save it” mantra isn’t fatalism. Instead, you should ask yourself, “By how much do their savings need to rise before they will start spending again?” – and ramp up your tax cut/helicopter drop/whatever accordingly.
I’m well-aware that stimulating demand isn’t everything, and has its own dangers. My point is that a plausible account of savers’ motives shows that, contrary to many, purely demand-based problems have been and remain easy to solve.