Obama’s Savings Plan Fights the Fed

(Originally published here.)

According to the Associated Press, tonight’s State of the Union address will include a plan sure to bother several Federal Reserve officials:

“Eager not to be limited by legislative gridlock, Obama on Tuesday is expected to announce executive actions on job training, retirement security and help for the long-term unemployed in finding work — all in addition to his order to increase the minimum wage on new federal contracts. Among them is a new retirement savings plan geared toward workers whose employers don’t currently offer such plans. The program would allow first-time savers to start building up savings in Treasury bonds that eventually could be converted into a traditional IRAs, according to two people who have discussed the proposal with the administration.”

Low-income households experience muchbigger swings in their earnings than other Americans because they are more likely to suffer from unemployment and reduced work hours in a recession. Yet these households are often the least likely to hold enough savings to carry them through tough times. One reason is that saving, along with a lot of other basic things such as housing and health care, is more expensive for poor people than for everyone else. No wonder less than aquarter of all Americans have enough stashed away to cover six months of expenses, while 27 percent have no savings at all. As if that weren’t bad enough, welfare benefits shrink as income rises, which perversely imposes crushing tax burdenson low-wage workers. Obama’s plan, as outlined by the AP, might be somewhat helpful.

So why should anyone at the Fed object? According to Charles Evans, the president of the Federal Reserve Bank of Chicago, orNarayana Kocherlakota, the president of the Federal Reserve Bank of Minneapolis, the big problem with the U.S. economy is that Americans are saving too much. That’s why the Fed has been so aggressive in attempting to push up inflation. The expectation is that this would erode the value of savings, encouraging people to spend more. In theory, the shift from saving to spending will boost growth and employment. Obama’s plan leans against this agenda by making it easier for those households with the greatest tendency to spend everything they earn to start putting some of their income away for a rainy day.

The best outcome is that higher saving rates among the poor would offset the unhealthydistributional effects of the Fed’s current strategy, which has pumped up asset prices held mainly by the well-off. Unfortunately, the Fed may choose to react to this new proposal by making saving even less attractive. We can only hope that the burden doesn’t fall too heavily on those of modest means.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)

To contact the writer of this article: Matthew C. Klein at mklein62@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.

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About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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