Monday, January 21, 2008

The 'Great Moderation' and the Income Volatility Question

Over at the CBO Director's Blog we read that based on the CBO's own research "household income is much less volatile than individual worker’s earnings, and that household income volatility has not increased over time — and perhaps even declined slightly." The period being studied here is from the early 1980s to the present. These results run contrary to the work of Jacob Hacker of Yale University who finds that the volatility of family income doubled between 1973 and 2004. Professor Hacker's response to the CBO Directors Blog can be found here.

A question: what role does the 'Great Moderation' play in this debate? A well documented fact is that there has been less volatility in aggregate economic activity since the early 1980s and this development is called the 'Great Moderation.' One study has found real economic activity volatility has fallen 50% over this time. Would not some of this decline in aggregate economic volatility be felt at the household or individual level? Is not the low U.S. household saving rates one indication of this development?

Some observers may look at the low U.S. saving rate and say it is the result of the global saving glut or the U.S. asset price booms. I am not convinced, though, these answers can provide the full explanation for the sustained downward trend in U.S. household savings. A more complete answer has to account for the possibility of improved household expectations arising from the long economic expansions of the past two decades that were interrupted by only mild economic downturns (i.e. the 'Great Moderation'). Any thoughts?

3 comments:

  1. Is saving low ? Ed Prescott doesnt think so - according to his article in WSJ:

    Myth No. 3: Americans don't save. This is a persistent misconception owing to a misunderstanding of what it means to save. To get a complete picture of savings we need to investigate economic wealth relative to income. Our traditional measures of savings and investment, the national accounts, do not include savings associated with tangible investments made by businesses and funded by retained earning, government investments (like roads and schools) and business intangible investments.

    If we want to know how much people are saving, we need to look at how much wealth they have. People invest themselves in many and varied ways beyond their traditional savings accounts. Viewing the full picture -- economic wealth -- Americans save as much as they always have; otherwise, their wealth relative to income would fall. We're saving the right amount.

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  2. Paul:

    I assume these intangible ways of saving have always been there. If so, then there would have to be a corresponding increase in them to offset the sustained decline in more traditional forms of saving for households over the past decade. Does the data show this?

    Also, what are the intangible ways households are saving more? You gave examples from business and government but not from households. I am guessing investing in human capital (e.g.more schooling, better healthcare) would be one example. But again, has this form of saving really increased enough to offset the more traditional forms of household saving?

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  3. I believe Prescott's take is that intangibles have indeed dramatically increased in the last 20 years - along with the rise of
    the information tech sector - more
    corporate and human capital. He
    views the increase in 1990s in number of "garage" IT entrepreneurs building up new companies pre-IPO as another type of household investment/saving

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