Here's a paragraph from a note by Neil Irwin, one of my favorite econ journalists (read his book):
I'm honestly not picking on Irwin; he's just relaying the standard story (and seriously, his book his awesome). I'm hoping someone can help me out here. Let's go through it piece by piece.
Ok, so far so good.
Ok. Poor people have lower MPC than rich people. Rich people are getting a larger share of "income", from the income fairies or wherever. Consumption spending is aggregate demand. So he's starting to lose me; I define aggregate demand as C+I+G+NX.
Hmm. So even over a 15-year period, output is constrained by demand (and demand=consumption). Output growth is determined entirely by consumption growth. I don't know what the mechanism is that translates consumption growth to output growth. And here is a nice counterfactual: "if there were more even distribution of income." What do you mean? Nobody is ever talking about after-tax income distribution in these discussions (well, only Scott Winship), and the higher moments of the income distribution are equilibrium outcomes, and even if you could move them exogenously I have no idea what that counterfactual looks like.
Ok, I have no idea what this means. But I hear people say it a lot, so it must be important.
So let me see how far I can get with a model. Let income be as in Piketty world--it's exogenous, manna from Heaven, except instead of manna it's a pie, right? Because we're always talking about how "the pie" is divided. So pies fall from the sky, and they come with strict instructions about how they are to be divided. And every year, for some reason, rich people are being assigned larger shares of the pie.
And in this model there is no investment. Also there is no government spending or trade (because aggregate demand=consumption, remember?). So output growth depends on consumption growth. Wait, so output growth is not actually exogenous. Well it's still exogenous; it's an exogenously specified process. The size of the pie this year depends on how much consumption grew the previous year, and of course that was driven entirely by the pie-dividing rule and MPCs. Or maybe it's all determined simultaneously--there's no capital, so it's basically a static model. I feel like we're going in circles, but let's press on.
Rich people are saving most of their income, but it has no effect on growth because there's no investment. Don't ask me where the savings goes, I guess it's government bonds, but there's no government spending (or if there is, it's the kind where they're just dumping money in the ocean, as in some simple Ramsey models). So rich people just keep saving and saving, and the savings stock is gonna get HUGE I guess, or we're burning it, but it's not going to do anything, and rich people will just keep saving because MPC is also exogenous in this model. And consumption growth is getting slower and slower; not only do rich people have a lower MPC than poor people, but their MPC is actually something close to zero.
With me so far? This is the secular stagnation model. It's not terribly different from the Eggertson and Mehrotra model. It's also the implicit model that Mian and Sufi use. They explain the investment problem with the zero lower bound. Remember that the Fed Funds rate is near zero, so returns to investment are zero, so there's no extra investment when rich people save. Ok? Like I said, I'm just trying to articulate my confusion. In any case the ZLB wasn't binding 15 years ago. Where was the savings going back then?
Maybe someone can help me understand this, but it looks to me like the secular stagnation model is just not ready for prime time. But you wouldn't know it from the amount of attention it gets! If you repeat something enough, maybe get S&P to write a lit review on it, it becomes fact, right? It's one of those ideas that people talk about because people are talking about it. Once a few people have said it, you can cite them authoritatively as evidence. They're using it to justify a story about inequality having a significant causal impact on growth--whatever that means, since inequality is endogenous in the real world (and so is income). We're a long way from really understanding this idea or even knowing if it's plausible. And what's most interesting is that the people who talk about it the most don't seem to be doing much to seriously explain it. I think most of them have no idea what kind of assumptions are packed into their model.
Somebody, please, write down a model of this so we can understand what everyone thinks is going on. I would do it but I can't think of any clever mechanisms to deliver the result. E&M have done all the work so far, but their model doesn't have capital yet (they say they're working on it). I can see that some people feel like this idea is really important. That's fair; persuade us by actually proposing some plausible mechanisms in a framework that includes things like aggregate resource constraints.
Or am I missing something obvious?![]()
The story goes like this: The wealthy tend to save a large proportion of their income, whereas middle and lower-income people spend almost all of what they earn. Because a rising share of income is going to the wealthy, spending — and hence aggregate demand — is rising more slowly than it would if there were more even distribution of income. Skyrocketing debt levels papered over this disconnect in the mid-2000s, but now we could be feeling its effect.
I'm honestly not picking on Irwin; he's just relaying the standard story (and seriously, his book his awesome). I'm hoping someone can help me out here. Let's go through it piece by piece.
The wealthy tend to save a large proportion of their income, whereas middle and lower-income people spend almost all of what they earn.
Ok, so far so good.
Because a rising share of income is going to the wealthy, spending — and hence aggregate demand —
Ok. Poor people have lower MPC than rich people. Rich people are getting a larger share of "income", from the income fairies or wherever. Consumption spending is aggregate demand. So he's starting to lose me; I define aggregate demand as C+I+G+NX.
and hence aggregate demand — is rising more slowly than it would if there were more even distribution of income.
Hmm. So even over a 15-year period, output is constrained by demand (and demand=consumption). Output growth is determined entirely by consumption growth. I don't know what the mechanism is that translates consumption growth to output growth. And here is a nice counterfactual: "if there were more even distribution of income." What do you mean? Nobody is ever talking about after-tax income distribution in these discussions (well, only Scott Winship), and the higher moments of the income distribution are equilibrium outcomes, and even if you could move them exogenously I have no idea what that counterfactual looks like.
Skyrocketing debt levels papered over this disconnect in the mid-2000s, but now we could be feeling its effect.
Ok, I have no idea what this means. But I hear people say it a lot, so it must be important.
So let me see how far I can get with a model. Let income be as in Piketty world--it's exogenous, manna from Heaven, except instead of manna it's a pie, right? Because we're always talking about how "the pie" is divided. So pies fall from the sky, and they come with strict instructions about how they are to be divided. And every year, for some reason, rich people are being assigned larger shares of the pie.
And in this model there is no investment. Also there is no government spending or trade (because aggregate demand=consumption, remember?). So output growth depends on consumption growth. Wait, so output growth is not actually exogenous. Well it's still exogenous; it's an exogenously specified process. The size of the pie this year depends on how much consumption grew the previous year, and of course that was driven entirely by the pie-dividing rule and MPCs. Or maybe it's all determined simultaneously--there's no capital, so it's basically a static model. I feel like we're going in circles, but let's press on.
Rich people are saving most of their income, but it has no effect on growth because there's no investment. Don't ask me where the savings goes, I guess it's government bonds, but there's no government spending (or if there is, it's the kind where they're just dumping money in the ocean, as in some simple Ramsey models). So rich people just keep saving and saving, and the savings stock is gonna get HUGE I guess, or we're burning it, but it's not going to do anything, and rich people will just keep saving because MPC is also exogenous in this model. And consumption growth is getting slower and slower; not only do rich people have a lower MPC than poor people, but their MPC is actually something close to zero.
With me so far? This is the secular stagnation model. It's not terribly different from the Eggertson and Mehrotra model. It's also the implicit model that Mian and Sufi use. They explain the investment problem with the zero lower bound. Remember that the Fed Funds rate is near zero, so returns to investment are zero, so there's no extra investment when rich people save. Ok? Like I said, I'm just trying to articulate my confusion. In any case the ZLB wasn't binding 15 years ago. Where was the savings going back then?
Maybe someone can help me understand this, but it looks to me like the secular stagnation model is just not ready for prime time. But you wouldn't know it from the amount of attention it gets! If you repeat something enough, maybe get S&P to write a lit review on it, it becomes fact, right? It's one of those ideas that people talk about because people are talking about it. Once a few people have said it, you can cite them authoritatively as evidence. They're using it to justify a story about inequality having a significant causal impact on growth--whatever that means, since inequality is endogenous in the real world (and so is income). We're a long way from really understanding this idea or even knowing if it's plausible. And what's most interesting is that the people who talk about it the most don't seem to be doing much to seriously explain it. I think most of them have no idea what kind of assumptions are packed into their model.
Somebody, please, write down a model of this so we can understand what everyone thinks is going on. I would do it but I can't think of any clever mechanisms to deliver the result. E&M have done all the work so far, but their model doesn't have capital yet (they say they're working on it). I can see that some people feel like this idea is really important. That's fair; persuade us by actually proposing some plausible mechanisms in a framework that includes things like aggregate resource constraints.
Or am I missing something obvious?