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Measuring Savings & Inflation

by James Kroeger


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One of the great analytical achievements of the modern era has been the use of mathematical tools to enhance our understanding of various phenomena.  Unfortunately, the existence of these tools has not guaranteed that they will be employed with sound methodologies or that the data collected will be properly interpreted.  The purpose of this essay is to point out how flaws in methodology and the interpretation of data have led to bad [economic] policy.



Many economists with good intentions are currently convinced that America ‘saves too little’ because they've noticed that the federal government's (NIPA) measurement of the 'National Savings Rate' has been declining over the past few decades.  What is not clear is why these analysts have ignored a more direct and far superior method of determining whether or not a society is ‘saving too little.’

Among the most basic of the fundamental truths that economists teach to their students every semester is the logical statement that All Income Is Either Saved Or Spent.  There is simply not a third possibility.  From this axiom, it follows logically that (1) all money not saved is spent and (2) all money not spent is saved.  It also means that saving can only be increased by decreasing spending and that spending can only be increased by decreasing saving, all else equal.

Now ponder the implications of another fundamental economic truth, one that all economists accept without question: All Jobs In The Economy Are Dependent On The Spending Of Consumers, Firms, Or Governments.  Since all jobs are dependent on spending, if aggregate spending were to drop significantly, jobs would disappear.  That is to say, the economy would go into a recession.  Alternatively, if aggregate spending increases---all else equal---jobs will be created.

When we recognize both of these fundamental economic truths at the same time, we are led logically to the conclusion that the only time we can legitimately complain that 'too little saving' is taking place is when the economy is booming, there is zero unemployment, and finance people are screaming at the top of their lungs that hyperinflation is threatening.  If there is any amount of unemployment in the economy, we can know with absolute certainty that a net increase in aggregate savings will---all else equal---cause a loss of jobs.

I suspect that many of the economists who currently claim that America needs to save more do not realize that they are actually saying that our nation needs to increase unemployment at a time when there are already not enough jobs available for all who need them.  This is equivalent to saying that a drop in Real Wealth production is needed in order for us to increase our nation's aggregate savings.  They don't seem to understand that, if we want to reduce unemployment (create/consume more real wealth) we must---all else equal---decrease savings (or tax/spend some money that has been saved) because we need to spend more.

So why is it that we cannot depend on the National Savings Rate to tell us if we are saving too much or too little?  Because it only attempts to tell us what percentage [of a certain measurement of] national income is not being spent [at least according to a certain measurement of total spending].  Whether they realize it or not, “We're saving too little!” economists are guilty of subscribing to the famous More Is Better Fallacy.  They believe that a declining Savings Rate is a bad thing because they believe that---at all times---'the more we save, the better off we are.’  It is a fateful error.

The practice of saving money is not a pure good that always leads to good consequences, no matter what the economic circumstances.  The Great Depression occurred for only one reason: those who had money in their possession that they could have spent, chose to save it instead.  Those who would have been happy to spend the money did not have it in their possession.

The only reason why the practice of saving money does not regularly do great harm to the economy is because most of the money that is saved is lent out to others who will spend it.  This helps to ameliorate much of the damage that the practice of saving money would otherwise inflict on the economy, but not all of it.  There is always a net leakage of money out of the economy whenever money is saved.  One major reason: any money that must be held by banks to satisfy the Fed's Reserve Requirement is money that is not returned to the economy that was once removed by saving.

Perhaps the biggest flaw in the NIPA  measurements is the fact that capital gains income is not included in calculations of total national income.  This, in spite of the fact that capital gains income is money that can be, and is, either saved or spent.  The BEA's calculation of the national savings (total national income minus total national spending) therefore ends up understating the total percentage of all income that is being saved (not spent).  If the spending numbers are dependable, then the higher income numbers will produce a higher calculated savings rate.

The only ‘rate’ the government calculates that we can rationally use to state whether or not our nation is saving enough is the unemployment rate (and yes, even that measurement is flawed).  If we actually had an accurate unemployment rate to work with, we could know with certainty that, when the unemployment rate is positive, we are saving too much.  When the unemployment rate just reaches zero, we could then say that our rate of savings is optimized.  If the unemployment rate is zero AND there is ‘too much inflation’, then we would be able to say with confidence that we are saving too little.



The idea of trying to measure inflation is a good one.  Theoretically, if we could measure inflation accurately, we would be able to say with great precision just how much we are ‘getting ahead’ or ‘falling behind’ with respect to the Cost Of Living.  The only problem is that the measurement we use (the CPI) is so poorly thought out, it is almost completely worthless as a tool of 'adjustment.'

Consider the fact that it is quite possible for different socio-economic groups to experience different inflation rates.  This is almost always the case.  Since the Republican Party began to cut the income tax rates of the wealthiest income earners in American in the 1980's, we have seen very substantial price inflation in those markets that serve the rich, while average prices for many in the lower classes have held somewhat steady or have even dropped somewhat (due to imports of cheaper foreign products and the loss of good paying jobs).

Because this variance in inflation rates across income groups exists, a far more useful CPI publication would provide different price index numbers for different income groups (meaning different ‘market baskets’ that are relevant to the different income groups).  This kind of data would require an enhanced data-collection effort, but the result would be worth it.  With data on the varying inflation rates that affect different income groups, policy makers would be able to fashion policy proposals that respect the varying circumstances of different citizens.

Once we have come to realize that it is actually possible for one income group to experience significant inflation while another income group is experiencing deflation, it no longer makes sense to compile an 'average' price index that supposedly affects ‘everyone.’  Doing so up to now has buried a lot of important information behind a single number.  If the BLS were to publish a spectrum of index numbers that pertain to maybe ten different income groups, both citizens and policy makers would have a much clearer picture of what is happening to the economy.






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