Saving graceMay 3rd 2007
From The Economist print edition
.....But could higher interest rates boost Japanese consumer spending? EVERY economics student learns that higher interest rates depress growth by curbing borrowing and spending. That, according to the conventional wisdom, is why the Bank of Japan (BoJ) must continue to hold interest rates at historically low levels; a rise in rates would risk tipping the economy back into recession and deflation.
Yet a few brave economists believe, to the contrary, that higher interest rates would actually encourage households to spend more, not less.
....The problem is that ultra-low interest rates risk creating economic distortions, such as the excessively weak yen, asset-price bubbles, or inefficient investment. Worse, low interest rates may themselves be discouraging consumers from opening up their wallets.
Debtors gain from low interest rates but savers lose, and Japanese households have the biggest stash of savings (relative to their income) among developed economies. Their net financial assets, excluding equities, amount to 3.2 times personal disposable income, compared with a ratio of only 1.9 in America and 1.1 in Germany (see left-hand chart). Over half of Japanese households' gross financial assets are in deposits that earn adjustable rates of interest (in America the figure is just over one-tenth), but only one-quarter of their liabilities are at floating interest rates.
.....Julian Jessop of Capital Economics. The impact of higher interest rates on spending depends upon the relative size of the income effect (higher rates boost income and hence expenditure) and the substitution effect (higher rates encourage people to save more). For small changes in interest rates, says Mr Jessop, the income effect may dominate, but for large changes the substitution effect may be more important.
Today is about macroeconomics. In Japan there exists a hot discussion whether BOJ (the Bank of Japan) should raise the interest rate or not. It is open to dispute politically and theoretically:
(1) Higher interest rates depress growth by curbing borrowing and spending. A rise in rates would risk tipping the economy back into recession and deflation.
(2) Higher interest rates would actually encourage households to spend more, not less. An ultra-low interest rates risk creating economic distortions, such as the excessively weak yen, asset-price bubbles, or inefficient investment.
Which sight is right? As Julian Jessop of Capital Economics says, it depends on the relative size of the income effect and the substitution effect.
Higher interest rates have two effects on the Japanese economy: income effect and substitution effect. This idea is convincing from the viewpoint of economics. Income effect means more income (and thus more expenditure) led by more interest revenue in the bank account due to higher rates, whereas the substitution effect more saving due to higher rates.
And for small changes in interest rates, says Mr. Jessop, the income effect may dominate, but for large changes the substitution effect may be more important.
Judgement on which is effective is related to empirics, so theory doesn't suggest that BOJ should raise the interest rate. However, my guess is that most of the Japanese people don't spend more but save more. The reason is that most of us have less to buy.
Rich countries like Japan also have the income and substitution effects of how wealthy they are; In richer countries, the richer people become, the more they buy(income effect), or the more they save(substitution effect). In rich countries consumers have two choices to make: to buy goods and service and to buy monetary goods. Monetary goods, which I coin, include saving, stock, bond and any financial derivatives.
One of my old teachers told me about the reason of recession: They spend less on goods but more on monetary goods like stock and bond. The more they earn, the more they desire not for goods but for saving, stock and bond. And thus the aggregate demand for goods decrease. Why do they pursue financial assets? Because they want no more goods.
However, whether they want goods or not depends on the relative size of the income effect and the substitution effect. And for small changes in wealth, the income effect may dominate, but for large changes the substitution effect may be more important.
In historical perspective, we Japanese have become much more wealthy since the end of WWⅡ. For large changes in national wealth, the substitution effect may be stronger than the income effect. And that's why we suffered an almost 10-year-long deflationary recession. What do you think of it? Let me know your frank comment!
2 comments:
It's interesting to think about the difference between U.S. and Japanese spending habits. In the U.S. it seems like everyone is in debt. Almost everyone I know has multiple forms of debt, from student loans to credit card debt to home equity loans.
It's almost hard for me to imagine a country where people save! People are very irresponsible with debt here, but it's partly becuase high costs force people into debt over things like medical and education expenses... and the credit industry gets away with murder these days, so they make it hard for people to get out of debt.
I'm curious, do you think the Japanese save more than Americans because they don't have the same high costs, or because they are simply more responsible? Do you have industries encouraging people to go into debt like we do?
Dear Di-Di,
Thank you for your comment. It is very important, di-di! This issue is important in economics, especially, macroeconomics. However, macroecon doesn't still tell what they save for. Rather macroeconomists have many reasons for their saving, and don't reach a simple conclusion. So the related researches are very exciting.
I'll post the related issues on saving later, but I want to answer your questions because I think your comment is to the point.
I hear many Americans are in debt. And I'm also in debt: I have a student loan. Every Japanese also has student loans, credit card debt and home equity loans because the living, education and hoousing expenses are also very high.
As you know, some visitors from abroad say that a Japanese house is like a rabbit hutch. I think the Japanese tend to live in a small house to keep their living expense low.
The Japanese are, as you say, save more than the American and many other peoples from the statistical data. But recently the Japanese have saved less because more people are getting older in Japan; The speed of aging people is more rapid than in the US. And needless to say, they are usually withdrawing their saving to keep their living. Some of them even borrow money on their pensions. In Japan consumer loans have become a serious social problem.
More Japanese are now saving less. The belief that the Japanese like saving will come to a myth.
However many Japanese still save more than Americans. I think it is rather because they had less social security like pension and medicare system in tha past than because they are very responsible.
They save more for their own future stable living, their children's education expense, or bequest for children. A bequest is thought to make children take good care of their old parents. This is called, "the strategic bequest motive" in economics. But it's an economist's idea not a fact. Nobody knows the reason for sure.
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