We doth blame the household too much

I was raised as a microeconomist so I guess I have a bias, but all this discussion about our poor debt position being the fault of households makes me nervous.

It is easy to blame households, hell the RBNZ did that just today. As they point out, household savings is extremely low, and real consumption (the volume of consumption in 1995/96 prices) as a share of GDP has risen sharply in recent years. On Sunday Rod Oram did the same – blaming our debt position on households spending far too much.

However, I find that when economists start to agree we are usually wrong. Given that this argument doesn’t feel right to me in the first place I am being forced to disagree.

I have two “pieces of evidence” to suggest that households aren’t at fault here, and instead it is weird investment incentives and poor government policy that is likely to be at fault. These are:

  1. My good friend Ricardian equivalence,
  2. Nominal GDP shares.

This discussion is a slight expansion on my recent Dom Post article (secondary link), and I am hoping everyone here will be willing to attack me as much as possible 😉

Ricardian equivalence

It is true, household savings rates have collapsed.  We have blamed house price growth in the past, but even so this might be a bit unfair when discussing aggregate consumption.

However, there is another reason why household savings maybe have collapsed – rising government savings.

from RBNZ speech

When government savings rises, households expectations for their future tax burden fall.  As a result, they can spend more out of current disposable income.

In this sense, we can see that it made some sense for household to borrow – as government was saving for them.  As government dis-saves going forward household savings should rise.

Nominal GDP shares

Now the Ricardian equivalence doesn’t tell us if households have been saving too much or too little, it merely gives us another reason why they have been borrowing.  To answer the question of whether we have been “consuming to much” we need to look at consumption as a % of GDP.

As the RBNZ likes to point out, the volume of consumption as a share of GDP has risen markedly in recent years – this does not seem sustainable.

However, if we instead look at “nominal” shares we get a different story.

from Infometrics article

Nominal consumption as a share of GDP has been very normal through the last decade – maybe even a little low.  Why?  Consumption good prices (relative to other goods) have collapsed!  Although we care about the “real” amounts, only looking at real ignores the impact of relative prices – which are extremely important.

This suggests that our rising current account deficit (which is also nominal) has allowed us to spend more and more on investment while maintaining consumption.

However, it appears that the investment hasn’t given us above trend growth – indicating that the rate of return on investment has been poor.  As a result, this graph tells me that we have an economy where government, business, and households have invested either poorly or unfortunately and now we are left with the bill.

What to do

This suggests to me that we need to have a look at why investment is heading into the wrong places, rather than criticising households for not being thrifty enough.  A few areas to look at are:

  1. Finance industry (RBNZ is on it, government is looking at boosting financial literacy),
  2. Tax policy (currently being looked at),
  3. Government spending and income levels (is the government being honest about the path of future policy?)

We don’t need households to be net savers, we don’t need to fiddle the exchange rate, but we do need to recognise that a net debt position nearing 100% of annual income (GDP) suggests that there are structural issues in the economy.

22 replies
  1. John
    John says:

    “When government savings rises, households expectations for their future tax burden fall”

    how do you equate that with “the average person wouldn’t know a budget deficit if he fell over one in the street” R D Muldoon?

  2. Matt Nolan
    Matt Nolan says:


    There are two reasons why I like Ricardian equivalence:

    1) It holds in the data, so there must be something to it.
    2) It makes sense when combined with the fact that people consume based on their “gross” wage, rather than their net wage.

    On the second point, people often complain that looking at gross wages is silly – people should look at net wages. But because the difference is tax, and given that we vote for a certain level of taxation, when the level of net tax rises past a certain level (as it has) people automatically start borrowing.

  3. Matt Nolan
    Matt Nolan says:


    My second point – fair call.

    I was just saying that it is possible people spend relative to their gross income instead of net income – which in turn would lead to the observation of Ricardian equivalence even if people didn’t explicitly plan to save in the face of govt deficits.

  4. agnitio
    agnitio says:

    You are going to need to explain that one to me given I tend to make my personal consumption decisions based on my after tax income.

  5. Matt Nolan
    Matt Nolan says:



    In essence you make the decision to shop based on your belief of future wealth right. This depends on future taxes, current and future income, and the value of your assets. Now if you are going to think of it at that level you will realise that government surpluses now mean lower taxes in the future – so you will borrow.

    However, if we move to someone who doesn’t think of any of that stuff, and we still observe Ricardian equivalence, we could appeal to a focus on gross wages instead of net wages.

    People will see that they earn a gross $40k a year, and they will spend $x on government services and $y on other things. Now in this case what they pay in taxes, $z, could differ from $x in a static sense – but over time the satisfaction of the government budget constraint implies that the infinite sum of the two flows must be equal. As a result, a society filled with people who base large purchasing decisions (houses, appliances etc) on their gross wage level will act like Ricardian equivalence holds.

    Now I don’t know if that is the rule of thumb people follow – however, it is a rule of thumb that would lead us to the observed result. We could instead assume that people follow the stream of future budget deficits/surpluses to figure out whether to borrow or save sure.

    But if households are as boundedly rational as John’s quote suggests, a gross wage spending rule of thumb will also satisfy Ricardian equivalence.

  6. talia
    talia says:

    @Matt Nolan
    That makes sense but I can’t help but be annoyed that we are even in this position in the first place. I was already living on a limited budget from month to month and now with the price of everything from broccoli to jewelry skyrocketing, I’ve had to tighten the belt even more. And I live in Canada where things aren’t as bad as some places like in the US.

  7. Yuva
    Yuva says:

    Yep, you are right. Its totally unfair to blame the households for this fiasco. I believe its the botching up with Macroeconomy by the policy makers thats having the ripple effect on the households and other microeconomies and not the other way around.

  8. Philly Jim
    Philly Jim says:

    From my perspective its the households which float our economies. Without all the worker ants how useful can the queen ant be?

    With the majority of global assets being controlled by a tiny percentage of people, households dont have a fighting chance and never had. The same story has played out in history many times.

    Human psychology is a major factor and moving forward we need many more safeguards. World leaders, economic leaders, and all who contribute to the status quo should seriously re examine their perspective and prejudices.

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