There’s a genre of jokes about the ivory tower propensities of economists, and the monetary economists at the Fed are reputed to be the worst of the bunch. But even allowing for those proclivities, the remarks by Bernanke yesterday about consumer behavior showed a remarkable lack of engagement with the real world. He and his colleagues clearly do not know, or bother to know, members of the dying breed known as the middle class.
Today, Bernanke said in a speech that consumers ought to be spending more. The fact that they aren’t means it must be due to mood, or as he put it, that they had become “exceptionally cautious.” Since economists believe that consumers are rational, this outburst of illogical behavior is unexpected and the Fed can’t be blamed for it. The New York Times dutifully did stenography and played up the confidence meme:
Economic models based on historic patterns of unemployment, wages, debt and housing prices suggest that people should be spending more money….
Why? Well, one possibility is that Americans collectively are suffering from what amounts to an economic version of post-traumatic stress disorder….
There is a longstanding debate among economists about the importance of confidence. Research has found that consumers are not very good at predicting the future. Optimism often fails to correlate with growth; pessimism doesn’t necessarily foreshadow a recession.
Still, it seems intuitive that a lack of confidence can drag on the economy. As pessimistic people pull back — deciding that there is no point in looking for work; that this is not the year to go on vacation; that it may make sense to stop eating in restaurants — the economy shrinks.
There is a natural instinct to address this problem by trying to cheer people up. Mr. Bernanke in recent speeches has been careful to note that he continues to think that the American economy has a bright future.
Let’s look at what the Fed chairman said. Because Fed chairmen make an art form of speaking in as anodyne a manner as possible, what is disturbing about his discussion may not jump put at you:
One striking aspect of the recovery is the unusual weakness in household spending. After contracting very sharply during the recession, consumer spending expanded moderately through 2010, only to decelerate in the first half of 2011. The temporary factors I mentioned earlier–the rise in commodity prices, which has hurt households’ purchasing power, and the disruption in manufacturing following the Japanese disaster, which reduced auto availability and hence sales–are partial explanations for this deceleration. But households are struggling with other important headwinds as well, including the persistently high level of unemployment, slow gains in wages for those who remain employed, falling house prices, and debt burdens that remain high for many, notwithstanding that households, in the aggregate, have been saving more and borrowing less. Even taking into account the many financial pressures they face, households seem exceptionally cautious. Indeed, readings on consumer confidence have fallen substantially in recent months as people have become more pessimistic about both economic conditions and their own financial prospects.
Can you see how disconnected this is? Start with the term “recovery”: Bernanke is comparing this bounce off a nasty bottom with past post-recession upturns. Hello! Did he somehow miss that severe financial crises are different beasts than recessions, where changes in inventory levels explain more than 100% of the change in GDP?
Not only is making comparisons to past recoveries wrongheaded, Bernanke completely misses fundamental, structural changes in the workplace:
1. Much lower labor participation in economic growth. Did Bernanke somehow miss that corporate profits are at a record high percentage of GDP? That pattern started in the weak Bush upturn. As we noted in 2005:
Part of the problem is that companies have not recycled the fruits of their growth back to their workers as they did in the past. In all previous postwar economic recoveries, the lion’s share of the increase in national income went to labor compensation (meaning increases in hiring, wages, and benefits) rather than corporate profits, according to the National Bureau of Economic Analysis. In the current upturn, not only is the proportion going to workers far lower than ever before—it is the first time that the share of GDP growth going to corporate coffers has exceeded the labor share.
So the outlook for labor has been permanently diminished due to the change in how much goes to workers v. profits.
2. Shorter job tenures. Does anyone other than tenured professors have job security? I’m sure you can add to that list (members of the armed forces) but even so, the incumbents will account for a small slice of the job market. Shorter job tenures mean: high odds of periods of unemployment (which means running down savings just to get by) and greater risk of downward mobility (as in difficulty of maintaining one’s earning level, assuming one ever had a good paying job).
3. Difficulty of staying employed over the age of 40. Item 2 + bias against older people means there are a tremendous number of the middle aged, which was once workers’ peak earning years, who are un and under-employed. Quite a few of my colleagues have retired early and resigned themselves to a very modest lifestyle when they would rather be working. At least they have that option; most ordinary people don’t.
4. Two income trap. Couples with kids are likely to be two income families. That puts them at serious risk of downward mobility, since it is harder for a family to cut expenses. Elizabeth Warren’s research showed that most two income families were not spending on frivolities; their costs had gone up due to a bidding war for housing in decent school districts, having a second car, and escalating medical costs. In the old days of a single (male) working parent, the wife was a worker in reserve who could supplement the family income if disaster struck. That sort of insurance is largely gone.
5. Higher loads of student debt. Even though Bernanke gave lip service to “the many financial pressures that households face” I suspect he does not grasp how student debt, which cannot be discharged in bankruptcy, affects behavior. Too many young people have been sold on the notion that a college education is necessary to get a job. Even where that is true, some then pursue career paths where they will have difficulty earning enough to service their debt
6. Worse prospects for retirement. Bernanke also stunningly missed how the risk of retirement income has been shifted onto consumers. Defined benefit plans have become defined contribution. People who thought they had a secure pension have had them cut back. And how do you earn enough to retire these days? MyLessThanPrimeBeef did some math:
If you make $50,000/yr before retirement and wish to have 60% of that after retirement, how much do you have to save in order to earn that much in your 0.5% bank account?
Let’s see, $50,000 x 0.6 = $30,000
@ 0.5% interest:
$30,000/0.005 = $6,000,000.
If you didn’t have to split it, throught out your working career, with the government and if you didn’t have to eat or support a family, it would only take you 120 years to save up $6,000,000.
Assuming you started working @ age 12, it would mean you can comfortably retire when you’re 132 yr. old.
Plan accordingly (for those without defined benefit plans)!
Now of course Bernanke would argue that assuming a 0.5% interest rate over 120 years is proof of undue pessimism, but making the assumptions more realistic (taxes, expenses, some reversals due to job interruption or emergencies) puts you in a not-very-different place.
This fundamental deterioration in the finances of ordinary households was masked by access to debt. When I was a kid, no one financed a car. And no one could use their house as an ATM. Too many assumed they could rely on house price appreciation as a proxy for saving. We know how that movie ended.
So independent of broadly-measured unemployment at over 16% and damage to consumer balance sheets thanks to the housing market implosion and fall in stock market prices from their bubble peak, there are really sound reasons for consumers to save a lot more than they did in the past, which means they spend less. Factor in how weak the economy is and how little confidence people have in our political and business leaders, and the conclusion is pretty clear: the irrational person in this picture is Bernanke, not the suffering and correctly cautious consumer.