Neil Irwin has an interesting piece in the NYT noting how high prices for a wide variety of assets have driven returns down to historical low levels. He notes that this is a predictable outcome, and in fact an intended result, of the low interest rate policy being pursued by the Fed and other central banks.

The idea is that high asset prices make it cheap for firms to borrow to finance new investment. They also make it easier to buy a home and allow many people who had higher interest rate mortgages to refinance into lower cost ones, thereby freeing up money for other types of consumption. There is also a wealth effect whereby higher stock and house prices will translate into increased consumption. Through these channels central banks hope to provide some boost to growth.

However the flip side of this policy is that investors can anticipate lower returns on their savings, unless they want to hold exceptionally risky assets. This is the idea of there being a savings glut, or as Irwin suggests today, a shortage of adequate investment opportunities.

The idea of a savings glut is not new, Ben Bernanke first mentioned it back in 2004 when he was a member of the Board of Governors. However the implications were not fully drawn out by Bernanke at the time or by Irwin in today's piece. A savings glut implies an economy that is not producing at its capacity.

To cut through the nonsense, savings in an economic sense means not spending. From the standpoint of the economy, it is just as much savings if you put $1,000 in the stock market, a checking account in your bank, stuff it under your mattress, or burn it in your fireplace. Anything that does not involve the purchase of a newly produced good or service means saving. Saying that we have a saving glut means we have an economy that does not generate enough demand to keep the economy at full employment. This is of course the story of secular stagnation that folks like Larry Summers have recently discovered and the problem that some of us pre-mature secular stagnationists have raised for years.    

The idea that the economy could be subject to an ongoing problem of inadequate demand used to be grounds for eviction from the realm of serious economists. But anyone who is willing to look at the evidence with a straight face really can't escape this conclusion.


The nice thing about problems of inadequate demand is that in principle they can be easily remedied. It's not hard in principle to create more demand. The first route is to have the government spend more money. That creates demand -- the government pays people to do things. There are a long list of things that need to be done. Think of all those things that we think that we can't do because they cost so much, like stopping global warming, educating our kids properly, or providing care for seniors. It turns out that we actually can do them because we have more supply than demand. We need to spend in these areas to fill the gap. 

But, that ain't going to happen. Some people are scared to step on the cracks in the sidewalks and some people are scared of deficit spending. Unfortunately, the latter group of people are running the country.

Item number two on the creating demand list is reducing the trade deficit. This one is straight out of intro econ. Our annual trade deficit of $500 billion corresponds to money that is created demand elsewhere rather than in the United States. The tried and true path for reducing the trade deficit is getting the dollar down. A dollar that costs less in terms of foreign currency makes our exports cheaper for people living in other countries and makes imports more expensive for people in the United States. The result is more exports and fewer imports, in other words a lower trade deficit. Eliminating the trade deficit altogether would pretty much close our demand gap, increasing GDP by around $750 billion a year.

Getting the dollar down is not a mystery either. It has been held up by the deliberate actions of other countries (most importantly China) buying up huge amounts of dollar denominated assets to keep up the value of the dollar and preserve their export markets in the United States. The way to reverse this pattern is to negotiate, as was done with the Plaza Accord under President Reagan in the 1980s. As a result of that agreement, the dollar fell sharply and the trade deficit was cut by two-thirds.

This doesn't happen today because powerful interests like Walmart, which has low cost supply chains in the developing world, and General Electric, which has factories hiring low-cost labor in the developing world, don't want to see the dollar fall since it would eat into their profits. There are also powerful companies, like Microsoft and Merck, that have their own demands that they don't want subordinated to efforts to get to full employment. Therefore we see little movement towards a lowered value dollar.

If we can't increase demand, the other route to full employment is to reduce the length of the work year. This has been done with enormous success by Germany which has lowered its unemployment rate to 5.1 percent, from 7.8 percent at the start of the downturn, in spite of having no more rapid growth than the United States. The average work year in Germany has 20 percent fewer hours than in the United States. The reduction in hours means five weeks a year of vacation, or more, paid family leaves, and shorter workweeks, all of which sound much better than millions of people being unemployed. 

We could go this route in the United States. In fact, California, New Jersey, Connecticut, and Rhode Island have already gone the route of paid family leave. However, there is a reluctance of politicians to suggest that less work might actually be good. And economists are still hesitant to accept the reality that we do in fact have a problem of too much supply.

Anyhow, the notion of a savings glut is hugely important for how we think about the economy. As long as the world suffers from a savings glut, it is a world where scarcity is not an issue. We have the ability to produce more of most goods and services. The problem is how to increase demand, not allocating "scarce" resources.