What is Savings? What is Spending?

The decline in world financial markets and the slowdown in economic growth has brought out many pundits with ideas on how to remedy things.

One of my problems with economic pundits is that they assume that words they use have a clear meaning. I'm currently having a problem with the words "savings" and "spending".

Economists think that there are two primary ways to influence economic activity which they like to give the fancy names of monetary and fiscal policy. What they mean is that they can adjust the tax rate or the central bank interest rate. There is unending discussion over which course to take, when to take it, and how effective it will be.

I'm sorry, but in my book when the most senior advisers on a topic have opposite ideas on a course of action I have to assume that they are motivated more by ideology than solid evidence from past events.

Those of a liberal bent are pushing for a tax break in the US. The argument goes like this:

A tax break, directed at those at the bottom of the economic heap, will be spent quickly and this added purchasing will lift the economy and avoid or blunt a recession. The plan worked out by congress only partially meets this goal. Much of the money will go to higher income people who will be less included to "spend" the money and will "save" it instead.

This is where I start to have a problem. I'll illustrate with a couple of homey examples. I dislike abstract discussions, it allows the pundits to remain vague while sounding profound.

Spending

I get a check from the government and take the money and buy a new gadget at the local emporium. I've "spent" it. The emporium takes the money and uses some of it to restock their shelves with more stuff. The profit goes into the running of the business or to the stockholders.

Saving

I get a check from the government and take to to my bank and deposit it. I've "invested" it. But what happens next? The bank doesn't stick it into the vault, it lends it out, let's say to a local merchant setting up a new store. What does he do with the money? He buys fixtures for his store, or he stocks his shelves with stuff.

I see no difference between the two cases. In the first I decide directly how the money will be spent, in the second I delegate the decision to the person getting loan. In both cases the money has gone back into circulation.

Then there are the fuzzy areas. I use it to pay off some of my outstanding credit card debit. Is this savings or spending? The bank which issued my card has gotten fresh capital which it can lend again, just as if I had deposited it directly. What about when the bank choses not to lend the money? This is a claim being made right now that markets are frozen. The bank is still not going to put the money in the vault. It will either cut back on the money it has borrowed from the central bank (if any) or it will buy treasury securities, that is, lend it to the government. Once again the money goes into circulation, the government now has less need to raise capital elsewhere.

I can see an argument that my buying a widget puts the money into circulation immediately while depositing it in the bank means that it will take a bit longer to start circulating again, but that's an issue of timeliness, not of saving vs spending. I hear no one making this argument with respect to a tax refund. There are such discussions taking place concerning using the money to boost government spending by increasing public works projects and the like, but not about tax rebates.

What I think I hear is the same old Puritanical moralism being disguised as economic theory. People who spend at once for personal reasons are profligate and this type of behavior should not be encouraged. People who are wealthier (and thus morally superior) will use the money wisely by saving it. This won't have the same economic boost so a quick tax rebate should be avoided.

Another axiom has to do with marginal tax rates. If the top tax rate is raised people will be disinclined to work as hard and entrepreneurs will be unwilling to start up new ventures. Some conservative commentators have even said that a $300-$600 check will cause workers to cut back on how hard they work. What is needed, according to this view of the world, is another permanent cut in the top tax rate. A temporary cut does not offer the right incentives to those who (apparently) make all decisions based upon their net take home earnings.

OK, I'm naive. What am I missing? What is spending and what is savings?


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Copyright © 2008 Robert D Feinman
Feel free to use the ideas, but the words are mine.