The emerging war on thrift
By Scott Sumner
Within the economics community, thrift was very fashionable during the neoliberal era (roughly 1980-2007). During the 2010s, economists opened a three front war on thrift. Thrift was blamed for rising inequality, stagnating aggregate demand, and debt problems associated with “currency manipulation”. In each case, the charges were false. Let’s consider them one at a time.
The most famous recent critique of inequality was Thomas Piketty’s book Capital in the Twenty-First Century. Piketty claimed that the forces of capitalism inevitably led to greater wealth inequality unless restrained in some fashion. He focused on the following inequality:
r > g
This means that the annual rate of return on capital assets usually exceeds the growth rate in the economy. You might argue that the recent risk free interest rate is lower than the trend rate of economic growth, but Piketty pointed out that returns on assets such as stocks and real estate have often exceeded the growth rate of the economy. As a result, wealth will accumulate at a pace that exceeds the growth in GDP, producing increasing wealth inequality.
For this theory to work, one needs to assume that the wealthy do not consume the returns on their capital. This is where thrift becomes the villain in the story. The greater the degree of thrift, the greater the growth in wealth inequality.
In my view, what matters is not wealth inequality, rather it is economic inequality; i.e. inequality in consumption. To the extent that I worry about economic inequality, I worry more about wealthy people with high levels of consumption (such as Larry Ellison) and less about wealthy individuals with low levels of consumption (such as Warren Buffett.) Saving by the ultra-wealthy might make wealth more unequal, but it makes consumption more equal.
The second front on the war on thrift opened in the 2010s, when a long period of near zero interest rates led to worry about monetary policy impotence. The root cause of the problem was believed to be the “paradox of thrift”—attempts to save more led to near zero interest rates and falling aggregate demand. Economists such as Krugman, Woodford, Eggertsson, and Summers worried that monetary policy would be ineffective at zero interest rates. Saving is contractionary in that sort of world, and fiscal deficits are needed in order to provide an adequate level of aggregate demand.
Long time readers know that I don’t buy this claim; monetary policy remains highly effective at near zero interest rates. If the world’s major central banks don’t know how to boost nominal spending, I’d be glad to show them.
The third front in the war on thrift emerged in the arena of international economics. Thrift in places like East Asia (especially China) and Northern Europe (especially Germany) were seen as leading to large current account surpluses, which somehow imposed harm on deficit countries.
One claim is that the current account surpluses had the effect of depressing global aggregate demand. But in that case, deficit countries could easily offset the effects with more expansionary monetary policies. Indeed this is exactly what the US did from 1985-2007. By 2007, our trade deficit had reached extremely high levels, but appropriate monetary policy kept unemployment low.
Another complaint was that these surpluses forced excessive borrowing on deficit countries such as Greece. But no one is forced to borrow. For instance, Australia kept its budget deficits at very low levels for decades, despite large and persistent current account deficits. Greece’s excessive public borrowing was an unfortunate policy decision, not something forced on Greece by German surpluses. Not all countries can have current account surpluses at the same time, but it’s possible for all countries to have budget surpluses at the same time.
I am a big fan of thrift, but at the moment my side is losing the battle. The US government is running up debts like a drunken sailor. All the energy in the economics profession is with the anti-thrift factions.
Someday the tide will turn and thrift will come back in style. Practices that are virtuous at the individual level are rarely harmful at the country level. Eventually it will be recognized that the thriftier nations tend to be the more successful nations.