A Supply Side Approach to the Crisis

by on September 25, 2008 at 7:33 am in Current Affairs, Economics | Permalink

Yesterday I pointed out that credit is still robust.  Growth rates are declining, however, and many people say the real crunch is around the corner.  Thus, today I want to suggest a new approach to dealing with the crisis that will have benefits regardless of how the crisis unfolds.

I see the key issue as follows: Banks bridge the gap between savers and firms.  We want to keep capital flowing to firms even when some of the bridges collapse.  One approach tries to prop up the collapsed bridges, a second approach tries to route funds across substitute bridges.  A third approach is to increase the flow pressure – in other words, I suggest a temporary but large stimulus to savings.

I suggest that for the next 12 months contributions to an IRA account will never be taxed.  We can modify this in various ways to cap contributions at a certain level etc.  We can even make the proposal progressive – for the next 12 months contributions to an IRA account will never be taxed and the government will match $1 for every $10 saved for anyone with income below a certain threshold.  The main idea is to increase savings.

The increase in savings will help deal with our current problems by offsetting any credit crunch.  (Some of the savings will also help to recapitalize banks.)  In addition, the U.S. needs a higher savings rate regardless.  During the 1990s as measured savings rates declined to zero commentators argued that rising asset values compensated.  Well asset values are now falling so true savings are negative – thus we need to increased savings.

A big benefit of this proposal – lower taxes, higher savings and a savings bonus to those with lower incomes – is that it should appeal to both the right and the left.

Zach September 25, 2008 at 8:21 am

The “saver’s credit” already exists. It begins at 50% for up to $2,000 of contributions and is phased out at $26,000 for singles. Check out IRS Form 8880.

As far as the plan to never tax IRA contributions, would you have to open a separate account for these tax-exempt contributions? In a traditional IRA, there’d be no way to tell tax-free gains from taxable gains. Although, you could add yet another line to the 1040 for the next 10 years that deduct Roth contributions from AGI. That way it’s deducted today and also not taxed at dispersement.

Andrew September 25, 2008 at 8:34 am

I think all other plans increase the public debt. Tax cuts don’t cause spending. Besides, you have to kick the dog that’s biting you today.

We don’t have a consumer spending problem. We seem to have a rolling-over-short-term debt problem. So, considering much of the savings would go into money markets and maybe CDs for first time savers, and the banks would have to do something with it, this seems sound.

Ixnay the welfare check and cut government spending to “pay” for it, and we have a deal.

Anonymous September 25, 2008 at 8:36 am

Umm … how well is the economy going to do if we all start suddenly saving more and spending less? Haven’t you just concocted a scheme for causing a major economic contraction?

Roland Stephen September 25, 2008 at 8:42 am

If its an institutional problem (balance sheets, credibility, confidence) then I’m not sure how this helps. Counties and municipalities in NC (triple A rating) having trouble floating construction bonds even as I write–that will certainly have a real economy impact.

Bonapart O Cunasa September 25, 2008 at 9:09 am

Is now really the time to be exacerbating the paradox of thrift?

Jesus saves America spends September 25, 2008 at 9:34 am

I prefer govt bailing out banks and going down with their debt. Isn’t this what we always wanted, drown the govt. It is time to celebrate, not save.

Robert Olson September 25, 2008 at 10:12 am

FIrst thing: Paradox of Thrift

Second: It’s only a temporary solution. It seems to me that there is a lot of adverse selection going on in the financial sector, so a lot of funds will just ignore it entirely and invest in the broader sector (or might even panic and flee the US altogether, figuring recession is right around the corner!). If the financial system doesn’t get capitalized but the broader economy gets more savings, it means a reprieve for the broader economy until the financial system.

Most estimates figure we’re halfway over, though, so maybe this IS a good plan. By the time the extra savings start flagging, the financial sector will recover.

Another funny:
Will this just cause savings to readjust from the future to the present, or will it actually increase present savings at no cost to future savings? If it’s a temporary tax cut, I’ll just take some of my contributions from the future and give them to my IRA now…so we’re trading off a present problem for a future problem.

Also, I will laugh like all hell if all the increased savings go to purchasing the Treasury Bonds used to fund the crisis. :)

Stan September 25, 2008 at 10:45 am

The New York Times [among others] has related taxpayers’ anger with CEOs.

I suppose I understand the public’s angst over executive pay [although I don't agree with it].

But in what way did corporate executives help “create this mess” as the Times contends?

Doesn’t the fault rest solely with borrowers who lied about their ability to pay off debt and the banks who processed their applications? Can someone help me out with this?

David R. Henderson September 25, 2008 at 10:53 am

Alex,
I like it, especially the Roth IRA deduction version. And one big benefit that I don’t think anyone above mentioned is that, for it to work, it doesn’t depend on putting enormous power in the hands of a lame-duck Treasury secretary who has so much of his own wealth at stake and who can choose to make investments that help him. It also avoids socialism or fascism, or whatever you want to call it, which the current plan doesn’t, not a small benefit.
Nicely done.
Best,
David

Anonymous September 25, 2008 at 11:13 am

In the last post, some of us were not merely arguing that the real crunch is around the corner; rather, it is upon us now, as of a week or so ago, in a way that is becoming clearer day by day.

Today’s datapoint: a chicken-processing company fell sharply (40%) today, because it waited too long to raise capital. Not significant in and of itself, but part of a pitter-patter of raindrops on a tin roof announcing that a downpour has begun and will intensify.

Christina September 25, 2008 at 11:38 am

While I, as a faithful Roth IRA contributor, like this idea from a personal standpoint, the Roth is hamstrung by a yearly cap on contributions of $5,000. Would you propose raising this as well?

bamboozlde September 25, 2008 at 12:03 pm

How about this for a possible fix:

With Secretary Paulson’s T.A.R.P. plan, the $700 billion used to purchase mortgage backed securities from financial institutions does not guarantee a correction of the four large concerns for our economy – 1) stabilization of the market, 2) improved liquidity for people or businesses, 3) increased investor (both foreign and domestic) confidence in the U.S. economy or 4) payment on the nearly 1.4 million mortgages currently in default in our country.

If there is to be a government sponsored nudge for our economy, perhaps the best way to spend the $700 billion would be to loan the money directly to the homeowners at a fixed, 30-year rate.

That way people get to retain their largest asset and consumer confidence grows, the banks get their money providing an increase in confidence in the banking sector, the investors of the mortgage backed securities get their money and their confidence – along with the confidence of all other foreign and domestic investors – not only stabilizes but increases and the U.S. economy is pulled out of its tailspin.

floccina September 25, 2008 at 12:16 pm

You could give the homes to habitat for humanity.

CJS September 25, 2008 at 1:02 pm

Mike Volpe:

Unless I’m mistaken, they are taxed now – it’s just deferred to a tax when the money comes out of the IRA. I think Alex was going with a combination of the IRA’s income-tax deduction upon contribution with a Roth IRA’s tax-free withdrawls and gains.

Alex: I’ve read that the savings rate doesn’t count money invested in stocks and bonds, which I presume is where most of the money put into IRAs would go. Is that correct?

gabe September 25, 2008 at 1:06 pm

The experts at the banks made crappy loans, not because they didn’t know they were crappy, but because they assumed the housing market would be bailed out and prices wouldn’t be allowed to fall. Now they can’t use their expert judgement to make MORE loans. That is why we need to push the crappy loans onto the taxpayers, so the experts can make more loans.

Oh I see how this will fix everything….for Goldman Sachs.

Garrett Schmitt September 25, 2008 at 5:38 pm

If the government and Federal reserve were to do nothing, we would have large-scale deflation. This would encourage increased saving which would serve as the natural equilibriating force to the credit crisis.

Instead the government proposes increasing its debt ceiling and borrowing another $700 billion. Imagine, borrowing $700 billion dollars to solve a general unwillingness to lend money, for what else is a credit crisis?!

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Credit is still robust? The seven-day rate for asset-backed commercial paper has jumped to 4.5% from the roughly 2.5% rate that prevailed over the past few months. Credit market is imploding as we speak

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