Wednesday, August 11, 2010

Why Did Savings Rise?

Question from Reader. This is in response to your interesting post "Talking Ourselves into Recession"

The crisis was manufactured so that the majority of us (suppose that means middle and lower classes) are nudged into saving more and borrowing less.
  • I don't think the crisis was manufactured to make people save more. In fact it is the opposite. The crisis occurred because some financial institutions tried to get people to borrow more than was responsible. Because banks (especially in US) lent mortgages to those who couldn't really afford it, many people later defaulted on these loans they could ill afford. Banks lost money and these financial losses spread throughout the world leading to the credit crunch.
  • The credit crisis occurred because banks and financial institutions had been lending too much, to the wrong people, and with inadequate checks on risk. The financial / economic crisis was a result of poor decisions, overconfidence, and an inability for free market to moderate its own excesses. (Credit crunch explained)
  • A consequence of the credit crunch is that banks rapidly made it difficult to borrow and encouraged saving to mend their shattered balance sheets. This rapid fall in lending (leading to lower consumer spending and investment) was one reason for the credit crisis turning into an economic recession (fall in GDP)
  • Consumers also saved more as a consequence of the recession. (People tend to save in periods of uncertainty with threat of unemployment)
  • After the recession hit, some policy makers actually tried to encourage spending. (e.g. VAT cuts in 2009) This is because if saving rises too quickly and spending falls, this can make recession worse. (see: Can a recession be avoided - written in 2008)
The goal is a macroeconomic rebalancing between G8-like countries and high growth countries like China. The underpinning assumption is that the economic "supremacy" of the western country has to be reaffirmed into some sudden yet sustainable way.

Before the credit crisis, the global economy was unbalanced. A very rough generalisation - the West spent and consumed, leading to trade deficit. The Chinese exported to the West, building up a large trade surplus. See: Global Imbalances for more info

This rebalancing of the world economy is undoubtedly beneficial, and is slowly occuring. A more balanced western economy will have less emphasise on consumer led growth and more production in the existing country.

Has such a statement some mileage? It does not seem to be to the advantage of the lower+middle classes (in the UK) since more of us are now likely to loose our jobs as a consequence of the crisis. Would this be indeed a good thing for western countries and if so who would be the clear winners and losers (in the rich countries as well as the others?).

A rebalancing of the economy should have benefits, e.g. possible job creation in manufacturing. The real pain is the current recession and high unemployment, which is liable to persist for a considerable time. But, if the growth in manufacturing continues, that will help create new job opportunities.

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