Intro to GDP, Consumption and saving

ENPC, 2nd year - SEGF

François Geerolf

OFCE/Sciences Po, CEPR

Consumption

Average

Expenditure : 1st, 5th, 10th Decile (in $)

Expenditure: 1st, 5th, 10th Decile (in %)

Detailed Expenditure by Decile (in $)

Detailed Expenditure by Decile (in %)

Consumption and Saving from the CEX

Consumption

Consumption (Log)

Saving

Saving Rate

Saving Rate (Log)

Euler equation

What do we know ?

  • What is the evidence on Permanent Income Theory / MPCs ?

  • What is the evidence for “Ricardian” equivalence” ?

  • The (limited) role of interest rates for consumption.

  • Accelerator and neoclassical views of investment. Interest rates and hurdle rates.

  • Elasticity pessimism; reconciling prices and quantities ? The difficulty of “production-based asset pricing”.

1321 pages Sargent & Ljungqvist (2018) textbook

Importance of PIH, the Euler equation

Themes on consumption

  • Is the Euler equation / permanent income a thing ? Liquidity ? “Wealthy hand to mouth” ?

  • What about “Ricardian equivalence” ? What’s the empirical evidence / justification ?

  • Revisiting “housing wealth effects”.

  • Importance of consumption / saving of the rich / very rich. Why do they save so much ?

  • Some references: Understanding consumption, Angus Deaton (1992); Jonathan Parker’s papers.

Parker (1999) - The Reaction of Household Consumption to Predictable Changes in Social Security Taxes

Idea

Main results

Break-down by types of consumption

Kueng (2018)

Data and Setting

  • Transaction-level account data from Personal Finance Website.

  • Quasi-natural experiments provided by the large annual Permanent Fund Dividend (PFD) payments from the Alaska Permanent Fund.

  • Since 1982, the fund has been making annual lump-sum payments of $1650 on average in October to every Alaskan citizen, including children. This amounts to a total payment of $4,600 for the average Alaskan household, which has 2.8 members.

Facts 1-3

  • Fact 1. The quarterly non durables MPC out of the PFD payments is 25% on average.

  • Fact 2. MPCs are heterogeneous across households, monotonically increasing with income, and the average response is largely driven by high-income households, who have MPCs above 50%.

  • Fact 3. Liquidity cannot explain the observed MPCs, because most households in the sample hold substantial amounts of liquid assets (both in levels and as a fraction of income), in particular these high-income households, who could easily smooth the PFD payments. In the data, I find that having few liquid assets (checking and saving account balances) predicts higher MPCs only for lower-income households.

Facts 4

  • Fact 4. There are no anticipation effects in nondurable spending, despite the fact that the payments are fully predetermined in September, when the governor announces the dividend, and highly predictable several months and often years in advance. (This absence of anticipation effects is evidence of excess smoothness) Instead, spending increases instantaneously by 12% in October when the dividend is distributed. A stable cumulative MPC of 25% is reached after only one quarter, that is, the impulse response function (IRF) of nondurables to these predictable income changes is flat after three months.

Cumulative MPC

Excess Sensitivity

“Ricardian” (Barro-Ricardo) equivalence ?

Complicated story

  • Story is very complicated. First, because Ricardo himself did not believe in what is now called “Ricardian” equivalence.

  • Moreover, this view is often misrepresented.

  • It is a view that is critical of Keynesian economics, but it is not against public debt. Argues that Keynesian stimulus is not efficient.

  • But this view is also critical of the crowding-out hypothesis, that is often used to criticize public debt and Keynesian economics. (public debt raises interest rates) Therefore, this view also asserts that the debt hawks are wrong.

Ricardo (1820) 1/4

Ricardo (1820) 2/4

Ricardo (1820) 3/4

Ricardo (1820) 4/4

Barro (1974)

Barro (1974)

Barro (1989)

O’Driscoll (1977)

O’Driscoll (1977)

O’Driscoll (1977)

Poterba and Summers (1987)

Overview

  • Clear evidence of a decline in national saving in the face of increased federal deficits.

  • Direct evidence that preannounced tax policies affect consumption spending when they are implemented.

  • Large real appreciation in the dollar and the associated trade deficit provide further support for the traditional view of the economic effects of the deficits.

The observation that real interest rates frequently fail to rise during wars, when nearly all theories predict they should rise, suggests that these findings may tell us more about our ignorance concerning interest rate determination than about the consumption effects of debt policies.

Overview

  • Changes in tax policy as a natural experiment.

  • In the face of exceptionally large peace-time government deficits during the 1980s, private saving has not increased and may well have declined.

  • This clearly violates Ricardian equivalence, or rather Ricardian non-equivalence Barro (1974), O’Driscoll (1977).

Overview

  • This is a macro identification strategy, using an event study. However, this holds true more generally:

    • Confirms microeconomic evidence that people do consume when face with lower taxes (even the non hand to mouth).

    • is confirmed by more extensive macroeconomic evidence.

Effects of deficit policies

Effects of deficit policies

Adjustable rates: Revisiting housing wealth effects

Share of variable rates

Intuition

  • Suppose your loan is interest only.

  • If interest rates go from 1% to 4%, with inflation going from 2% to 5% than your rate goes from 1% to 4%, and your monthly payments are multiplied by 4.

  • In principle the value of your loan is diminished by that amount, so you should borrow to pay these.

  • Of course, you will face borrowing constraints. (and probably not even think about it in this way)

  • Application: Revisiting “housing wealth effects”. (including one of my earlier papers…)

Fed Funds Rate

Mortgage Payments (% of Disposable Income)

Fed Funds Rate / Mortgage Payments

Carroll (2000)

Why do the rich save so much?

  • Cole, Mailath, and Postlewaite (1992) took the example of Donald Trump (!) to show that often, the consumption motive fails to explain why such already rich individuals work so much, and propose the rat race explanation:

But think for a moment about an already very rich agent such as Donald Trump. Why does he continue to work long days, endure substantial amounts of stress, and take enormous risks? Surely it cannot be that he is savoring the prospect of going to the grocery store with a looser budget constraint next year. He seems to have more money than he could spend in several lifetimes. Even if we are wrong about Trump’s net worth, there clearly seem to be wealthy individuals that continue to work very hard and take large risks to increase their net worth. It is hard to reconcile such behavior with the underlying decision making in traditional growth models. We propose that people like Trump continue to care about increasing their net worth because their utility depends not only on the absolute level of their wealth but also on their wealth relative to that of other very rich people.

Why do the rich save so much ?

  • Carroll (2000) - The rich save really a lot, and we do not quite understand why they do save so much. Macroeconomics models: saving for bequests ?

  • In the 1992 SCF, only 2% of the wealthy households, indicated that providing an inheritance was the most important reason to save. In fact, even the elderly save.

  • Moreover, Kotlikoff and Summers (1981) have shown that a small fraction of aggregate wealth is actually due to life-cycle saving.

  • “Another obvious test of the model is to see whether the childless elderly tend to dissave more than those with children. This hypothesis has been tested using population-representative data; Hurd (1986) found that in the population as a whole, there is no tendency for elderly with children to decumulate faster than those without.”

Why do the rich save so much?

Saez and Zucman (2016)

The rich save

Lifecycle, Bequests?

Top 10% Wealth Share: about 75% of wealth

Top 1% higher than Top 10-1%

Saving

Saez and Zucman (2016) - Saving Rate by Income

Saving Rate by Wealth

Top 1-10% and Top 1% wealth share

The global wealth pyramid, 2019

Global debt (public + private) = $188Tn. IMF

Number of dollar millionaires (% of world total)

Change in household wealth by region

Utility for money / wealth

Saving of the Very Rich

Adam Smith (1759) - Theory of Moral Sentiments

Lee Iacocca

  • Lee Iacocca, former CEO from Chrysler:

Once you reach a certain level in a material way, what more can you do? You can’t eat more than three meals a day; you’ll kill yourself. You can’t wear two suits one over the other. You might now have three cars in your garage-but six! Oh, you can indulge yourself, but only to a point.

Keynes

Who wants to be a millionaire ?

How to spend it

Bibliography

Bibliography

Barro, Robert J. 1974. “Are Government Bonds Net Wealth?” Journal of Political Economy 82 (6): 1095–1117. http://www.jstor.org/stable/1830663.
Carroll, Christopher D. 2000. “Why Do the Rich Save So Much ?” In Does Atlas Shrug? The Economic Consequences of Taxing the Rich, edited by Joel B. Slemrod. Vol. D. Harvard Univ Pr.
Cole, Harold L., George J. Mailath, and Andrew Postlewaite. 1992. “Social Norms, Savings Behavior, and Growth.” Journal of Political Economy 100 (6): 1092–1125. https://doi.org/10.1086/261855.
Kotlikoff, Laurence J., and Lawrence H. Summers. 1981. “The Role of Intergenerational Transfers in Aggregate Capital Accumulation.” Journal of Political Economy 89 (4): 706–32. http://www.jstor.org/stable/1833031.
Kueng, Lorenz. 2018. “Excess Sensitivity of High-Income Consumers.” The Quarterly Journal of Economics 133 (4): 1693–1751. https://doi.org/10.1093/qje/qjy014.
O’Driscoll, Gerald P. 1977. “The Ricardian Nonequivalence Theorem.” Journal of Political Economy 85 (1): 207–10. https://doi.org/10.1086/260552.
Ricardo, David. 1820. Essays on the Funding System.
Saez, Emmanuel, and Gabriel Zucman. 2016. “Wealth Inequality in the United States Since 1913: Evidence from Capitalized Income Tax Data.” The Quarterly Journal of Economics 131 (2): 519–78. https://doi.org/10.1093/qje/qjw004.
Smith, Adam. 1759. The Theory of Moral Sentiments. Penguin.