(Originally published here.)
Yesterday, my colleague Caroline Baum sarcastically suggested that the government give “every household a pre-loaded gift card.” She thought the proposal was so ludicrous on its face that it would force people like me to apologize for ever having suggested that lower taxes and higher levels of government spending make sense when households and businesses want to repay their debts and increase their savings. Trouble is, it’s a good idea.
Since 2007, U.S. households and businesses have been trying to repay their debts and rebuild their savings — a major change in behavior from the previous 25 years. The stock of nonfinancial private debt soared from about 95 percent of gross domestic product in 1982 to about 170 percent of GDP by the eve of the crisis. At the same time, U.S. households started taking a lot more risks with their savings: The share of household wealth held in safe, liquid assets fell to less than 8 percent between 1982 and 2007, from a postwar average of about 16 percent.
The reversal of these trends over the past few years is a welcome development, although we may have a long way to go before the process is complete. Bigger government budget deficits and higher levels of public indebtedness since 2007 are consequences of this private deleveraging, as Martin Wolf has explained so well. It all boils down to the fact that one person’s spending is another’s income. Similarly, one person’s borrowing is another’s lending. The takeaway is that the private sector as a whole can’t switch from borrowing and spending to repaying debt and saving unless some other entities (foreigners and the government) step in.
The contraction of the current account deficit since 2006 has been helpful in this regard, but insufficient. That’s why the federal government had to run very large budget deficits. These deficits helped the private sector in two ways. First, by spending more than it took in through taxes, the government added to the private sector’s total income, making it easier for people to repay debts and save more. Second, the government financed the extra borrowing by issuing trillions of dollars of new Treasuries, which helped satiate the heightened demand for safe dollar-denominated assets.
The government’s efforts helped prevent the contraction from being even worse, although they were insufficient to induce a robust recovery. Tellingly, the ratio of all nonfinancial debt to GDP has been flat for years, despite massive budget deficits and a large increase in the ratio of government debt to national income. In other words, the U.S. private sector is still deleveraging. Efforts by the U.S. government and the Federal Reserve have only kept the economy treading water. Doing more would be desirable.
The question, then, is what more should be done? Plenty of people have argued for more aggressive monetary policy, although I think there are dangers in relying too heavily on that channel. Moreover, it isn’t clear how much additional firepower the Fed is even capable of deploying at this point. Ideally, we could just hand cash to people and let them do with it as they will, as Matt Yglesias has frequently recommended. Some might use the cash to build up a bigger buffer of liquid savings. Others might repay their old debts, while others could spend the money on goods and services.
Baum’s plan isn’t ideal, because it doesn’t seem that her gift cards could be used for debt repayment. But it’s still a pretty great idea.
(Matthew C. Klein is a contributor to the Ticker. Follow him on Twitter.)