Five macroeconomic myths?

Here is Ed Prescott’s list.  Here is the thumbnail version:

Myth No. 1: Monetary policy causes booms and busts
Myth No. 2: GDP growth was extraordinary in the 1990s
Myth No. 3: Americans don’t save
Myth No. 4: The U.S. government debt is big
Myth No. 5: Government debt is a burden on our grandchildren

Where to start?

In my view #1 is 53 percent true, not a myth, #2 is a debate over semantics, #3 is indeed a myth though we should save a bit more, interpreted literally #4 is myth but let’s not forget the real problem is forthcoming demographics combined with Medicare, and #5 is mostly a myth although the illusory "government debt is net wealth so let’s spend more than we ought to, thereby reducing the capital stock" effect is not zero.


Saying that the US government debt is not big, by ignoring the parts that are accumulating the giagantic debt..... is most unfortunate.

Kotlikoff says that with the coming retirement of the "baby boomers" we'd need a 109% increase in payroll taxes to right our fiscal affairs. Or some other bunch of remarkable adjustments.

Is Professor K way off here?

Whether foreigners or Americans own U.S. debt only has implications for the distribution of the burden (along with who pays taxes) not whether or not it is a burden.

The other problem with debt is that the burden depends a lot on what happens to long-term interest rates in the future. Add to this the fact that an increase in the debt has a small but still very real effect on long-term interest rates and debt becomes more of a problem. Right now, long-term interest rates on U.S. debt are extraordinarily low but few people expect this to last unless policies in the U.S. change.

Concerning #1 : Is your view of 53% truth representative of the relative weights you assign to the explanatory power of Austrian business cycle theory and RBC theory?

The assertion that “Americans don’t save† is simply a fact. Check out the NIPA data over at (Table 2.1 and Table 5.1). Back in 1992 personal savings were 5.78% of GDP. In 2006 they have approached -1% of GDP. A personal savings rate of roughly 6% back in 1992 may or may not have been adequate. Presumably -1% is not.

This trend has been noted many times in many places. Take a look at the following graphs,, and

The decline in personal savings probably has several origins. However, the wealth effect would appear to be dominant. As wealth has risen savings have declined. Indeed, MEW (Mortgage Equity Withdrawal) has become a major source of cash flow for current expenditures. See and for some MEW statistics. See and for some statistics on household net worth.

Current household wealth is dominated by housing. If anyone thinks current house prices can be sustained take a look at How many letters are there in “bubble†? The reality is that housing prices will revert to trend over time and the wealth effect will disappear. As it does, savings will rise and domestic expenditures will fall. Unless exports rise exactly in tandem, the adjustment process will be painful. Given the existence of Bretton Woods II (de facto fixed exchange rates), the opportunity for an easy expansion of exports to replace domestic demand is precluded. The outcome may not be pretty.

Overall, Americans are not saving enough. Personal savings have gone negative. The corporate sector does generate some net savings. However, government (state and federal) has net deficits. Overall, total savings are 1.7% of GDP of late (Q2 and Q3 of 2006). Throughout most of the post WWII period this number was around 10% of GDP.

Also, I wonder if the decline in personal savings rates tracks the raise in the maximums for 401K and IRA contributions over the past few years - since money that used to be saved in post-tax accounts - and counted in the personal savings rate - can now fund a 401K or IRA. I've frankly found the "sudden discovery of profligacy" narrative rather tiresome, since consumer capitalism wasn't exactly discovered yesterday. I suppose new home loan vehicles are be pumping some people into higher levels of spending stupidity, but my suspicion is that this is overrated.


I was mistaken about one point. Apparently the Department of Commerce does include in disposable income an employer's contributions to pensions funds, to insurance funds, and to government social insurance (social security). I can't tell from the definition whether or not that includes employer contribution to 401K plans.

I do not see in the definition any reduction for employee contributions to 401K or other tax-deferred savings plans.

Here's the link:

eddie: "Why the fascination with savings as defined by "wages and dividends minus expenses"? "

Well, it is a number for which we have historical data.

From the end of the depression, 1950, through 1992, the U.S. personal savings rate remained above 7 percent and averaged about 9%. It was even higher during the World War II years, presumably because Americans bought war bonds.

Since 1992, the personal savings rate has steadily declined until it was negative in 2005. This is not a seesaw pattern, where savings are up one year and down another. Additions to personal savings remain down sharply, and this is unprecendented in the post-Great depression era.

What's troubling to me is that 1992-2005 should have been wealth accumulation years for Boomers. That's especially true if they believed that either Social Security or Medicare may not be fully funded during their retirement. If you've talked to many Boomers - I am one and I have talked to others - you'd know that most have been saying they're not counting on Social Security and Medicare. But they're also not saving at the same rate as their parents were. Some are saving more, but overall they just aren't showing the same behavior that preceding generations have.

I foresee problems in 20 years when many Boomers won't have the savings to meet the high costs of medical insurance. Boomers may expect their grandchildren to pay for - through Medicare taxes - almost all of their health expenses. That's just wrong.

Peter, thanks for clearing up teh definitions.

I am surprised the 401K total is that small. As most plans contain some amount of employer match, it's hard to believe employees can just forego compensation. But I know that many do. I wonder how much it would raise median income if employees would stop being stupid.

steve: "When people retire, I expect their spending to remain relatively constant, but their income to drop."

I think that's true. The leading edge of the baby boomers is just entering retirement age. Those born in 1946 are now 60. We can expect those boomers to stop funding 401K's, stop accumulating pension assets, and stop paying FICA taxes, all of which would be considered savings.

The personal savings rate has been steadily declining since 1992. Boomers have been in their peak earnings years the past 14 years. They should have been saving more after the kids left home and as the Boomers neared retirement. The savings rate should have risen since 1992, not dropped.


The problems associated with treating capital gains as savings are not just matters of language. The real issues are whether they (the gains) can be maintained long enough to support the retirement of millions of Americans.

Isn't there a reciprocal question of whether real incomes can be maintained?

I'm having a hard time distinguishing between getting a $10,000 Christmas bonus and seeing a $10,000 rise in my stock portfolio (tax implications aside). In either case, I'm going to spend the same amount, and whatever's left over is going into my portfolio. Why should we be more worried about the second case than the first case? The end result is the same: in both cases everyone's net worth has the same value and is held in the same manner, and everyone has the same consumption. Only the "savings rate" is different. Why is this not merely a matter of language? Where is the economic difference?

If you think that there is a difference, I'd be happy to trade you the most recent $10,000 your stock portfolio went up in exchange for a contract job paying $9,000 for writing a blog post explaining the difference.

The $10K bonus is yours to keep forever.

Unless I put it in the stock market, at which point it will eventually disappear when the market reverts to the mean.

The $10K gain in your portfolio can and will mean revert.

Unless I cash it out and put it in my mattress (or bonds or gold or some other asset I might guess is underpriced rather than overpriced).

What happens to my money after I get it depends on what form I keep it in and is independent of how I got it in the first place. The only difference how I got it makes is to the savings rate. What am I missing here?

Real savings requires deferring consumption and using the forgone consumption to create assets. Transitory capital gains don’t suffice. [Emphasis added]

I think the key term here is "transitory". Considering that word, I'd agree with you. But I think the world of difference lies within that word. I don't dispute that capital gains can be transitory; you seem to be taking the position that capital gains are of necessity transitory.

If assets were always correctly priced, so that a dollar of capital gain reflected a dollar's worth of actual increase in the value of the underlying asset (say, for example, an apple tree that had grown slightly larger and now produced slightly more pies per year) - wouldn't such capital gains be as good as deferred income? And if so, then pray tell, how are we to determine the correct prices of assets? Is everyone dumping their 401K money into index funds just a bunch of suckers who obviously don't understand the implications of Tobin's Q?

Wealth and/or assets are very different things then savings.

Wealth can change for many reasons. But it still comes down to ownership of an asset.
You can borrow against wealth to finance consumption or investments, but you can not directly use it to finance consumption or investment. If you borrow against it it means someone else has given up the use of the resource you are now using so there is
no net change. That is the big difference between wealth and savings. Savings is foregoing current consumption and diverting resources to other purposes.
But wealth is not that.

the dominant reason we have a current account deficit is to cover the drop in personal savings over the last quarter century. If savings had not fallen we would not need the foreign savings.

The attempt to make savings and wealth sysnonymous by people like Prescott is one of the most misleading uses of economics ever. It is an act of deliberately dishonesty to advance an ideological point of view and to hide the failure of the economic policies they have advocated for a quarter century.

Thank you Peter Schaeffer for your corrections on the 401K meme.

eddie --- the only way you can take your money out of your Schwab account and spend it is to find another individual to buy it from you. That is what Schwab does, acts as a middleman and it earns its keep by charging a fee to you for finding a buyer.
That is why in the discussion above brokerage fees are included in the calculation of gdp.

Individuals can do what you say, but the whole population can not do it.


If you put $10K into the stock market, mean reversion implies either gains or losses depending whether the market is undervalued or overvalued. If the market is 100% overvalued, you should expect to loose half of your $10K, not all of it.

The origin of your money does make a difference. If you obtained $10K via work and chose not to spend it, you are deferring potential consumption of $10K worth of resources. That is savings for you and the economy as a whole. If the $10K came from a transitory capital gain, either you or the buyer of the inflated asset will loose the $10K at some point.

You are correct in asserting that not all asset price increases are transitory. Yes, a bigger apple tree with more apples each season is worth more. Share prices should (and overall do) rise to the extent that corporations reinvest undistributed profits. For tax purposes, this is classified as a capital gain. However, a better analogy would be a bank account that goes up as more money is deposited into it. No one would call the increase in the bank account a “capital gain†. However, conventional terminology (and tax law) does apply that phrase to stock price increases derived from retention of earnings.

The key point is that gains from reinvestment of profits are not large. Take a look at a chart of the S&P adjusted for inflation ( Stock prices have only doubled in real terms since the 1960s. If we netted out gains from reinvestment of profits, share prices may be essentially unchanged from 40 years ago (Tobin and Shiller’s point). Stated differently there have been roughly zero net capital gains from stocks over the time period in question. Share price increases from reinvestment of profits? Yes. True enduring capital gains, very few if any.


Your assessment of the politics of this issue is entirely correct. An entire class of politicians, financiers, and economists are trying to use higher asset values to justify all that has gone wrong. The voters didn’t buy it.

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