Would more planned savings be good? How can we lower perceived risk premia?

One common claim these days can be put in terms of the expectations theory of the term structure: since short-term rates cannot much fall, long-term rates cannot much fall either. 

Yet I would not put this argument forward as the best available understanding of the issue.  First, the expectations theory of the term structure has a dubious empirical record.  Long and short rates change for somewhat mysterious reasons and the long rates do not forecast future short rates very well.  Second, there is a distinction between Treasury and corporate rates and the latter are not zero, especially for small businesses.  

One possibility is that true corporate real rates are better reflected by the status of letters of credit, standby loan agreements, and the like.  One can view borrowing in terms of the value of an option, rather than a single numerical rate.  Many businesses no longer feel they have lots of liquidity "on tap" when they might need it from their banks and so they hesitate.

In general, I think of this crisis as having damaged a lot of agency relationships, and as having led to tighter leashes.  For instance, if you are a worker of um…"ambiguous" marginal product you may no longer get the benefit of the doubt.  The high perceived risk premium in the labor market is preventing a lot of reemployment.

Returning to interest rates, the question is what could call true real rates to fall.  The expectations theory of the term structure is not very useful in analyzing this problem.  Changes in the perceived risk premium have been an embarassment and a confounding factor for the expectations theory for a long time.

Given that background, should we plan to save more?  On the no side, I would not push "more savings" is the magical elixir in lowering real rates, since the major issue is again the perceived risk premium.

(By the way, if we lower real rates through Sumneresque inflation — which I favor — we are altering the spectrum of these agency dealings and injecting more risk into those relationships, possibly in a socially optimal manner; in any case that second-order effect has not seen enough analysis.)

Another anti-savings argument runs like this: if we switch from spending to savings, that requires longer-term production processes and resource reallocations.  The new market forecasts of what to produce involve greater risk, namely Keynes's "dark forces of time and ignorance".  If that increase in the risk is too stiff, an increase in planned savings could lead to a greater collapse in output, exacerbating both AD and AS problems.

A pro-savings argument runs like this: We're overly dependent on Chinese capital.  T-Bill auctions are now being soaked up much more by domestic lenders and that is a good thing for the world state where the Chinese economy implodes.

Another pro-savings argument is about balance sheet repair and about satisfying the preferences of consumers for greater long-term risk protection.

A major pro-savings argument is: If savings are not to go up now (and they have been rising since the onset of the crisis, supposed Keynesian paradoxes aside), then when?

The long-run boundary conditions require Americans to save more at some point and here's a fundamental point about macro.  I believe we are in a situation where the short-run and long-term boundary conditions are interacting.  People want to see the longer-term "we have to save more" problem (as well as some other longer-term problems) partially resolved before having much lower shorter-term risk premia and thus a freer flow of capital and private investment and also more ambitious hiring policies.

That makes the ride especially bumpy and the recovery especially slow.  Both the long-run and short-run conditions require partial resolution, at the same time, and yet the long- and short-run conditions point in some different directions.

I get nervous when I see Keynesian models emphasizing the short-term only or non-Keynesian approaches emphasizing the long-term only.  The more insightful approaches see the short-term and long-term factors interacting in a not always so helpful manner.

Addendum: Krugman has a recent post on savings.  I am confused by his insertion of the Fed into the classical loanable funds mechanism, which does not require a central bank.  I am also surprised that he associates the paradox of saving with the liquidity trap; Keynes for instance believed in the paradox of saving even though he thought he had never seen a liquidity trap.  It could be, however, that I am misreading him on both counts; I found the post difficult to parse.


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