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:
- My good friend Ricardian equivalence,
- Nominal GDP shares.
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:
- Finance industry (RBNZ is on it, government is looking at boosting financial literacy),
- Tax policy (currently being looked at),
- 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.