from Follow the Money

Yet more on Bernanke and the savings glut

October 28, 2005

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Brad DeLong seems to have dug up what Dr. Bernanke thought about fiscal deficits before he discovered the global savings glut ...  namely, structural fiscal deficits tend to raise real interest rates. 

Suppose the government increases spending without raising taxes, thereby increasing its budget deficit.... An increase in the government budget deficit... reduces public saving... [and] will reduce national saving as well.... At the new equilibrium F', the real interest rate is higher at r', and both national saving and investment are lower... the government has dipped further into the pool of private savings to borrow the funds to finance its budget deficit... investors [must] compete for a smaller quantity of available saving, driving up the real interest rate... mak[ing] investment less attractive, assuring that investment will decrease along with national saving.

In his savings glut speech, Bernanke makes a slightly different argument.  The US fiscal deficit is all that stands between the US and even lower real interest rates and even more investment in housing.  Actually, the US fiscal deficit and the US consumer's willingness to spend is all that stands between an even larger savings glut (equivalently, a global shortage of consumption and investment) and even lower real interest rates around the world.

The key quote (emphasis added): 

According to the story I have sketched thus far, events outside U.S. borders--such as the financial crises that induced emerging-market countries to switch from being international borrowers to international lenders--have played an important role in the evolution of the U.S. current account deficit, with transmission occurring primarily through endogenous changes in equity values, house prices, real interest rates, and the exchange value of the dollar.

Note the variable that Bernanke left out - namely the increase in the US fiscal deficit.

Bernanke's thesis (taken to its extreme) suggests that the US is doing the world a favor by spending so much and being so willing to borrow their funds; that implication - and the implication that US policies bear no responsibility for the rising US current account deficit - certainly bothers me.   I don't think today's US current account deficit is the simple response to a shortage of spending abroad, and would be the same irregardless of US fiscal policy choices.  Nor does borrowing abroad to finance fiscal deficits, high levels of consumption and investment in residential real estate obviously create the future export revenues needed to pay the interest on the United States' rising external debt.

But Bernanke was responding to a real puzzle. As Dr. Altig notes: a shift from a structural fiscal surplus of maybe 0.5%  of GDP to a structural deficit of close to 3% of GDP, according to standard models, should have pushed up real interest rate and crowded out investment, particularly in residential housing.   It didn't. 

The absence of higher real interest rates is what led Bernanke to postulate a global savings glut - a thesis that has now been refined into a "fall in investment relative to savings" outside the US, and particularly in emerging economies.

And in some ways, it is not that different from the answer to the low interest rate puzzle that Nouriel, I and many others have put forward - a surge in reserve accumulation by emerging economies (with reserve accumulation defined broadly enough to include the investment funds of the big oil exporters).   As I never stop pointing out, private capital is pouring into emerging economies, but by using this capital inflow to grow their reserves, emerging economies have chosen to use that capital to support the US government bond market (and in China's case, the mortgage backed securities market) - not to finance higher levels of investment or higher levels of consumption.

I tend to emphasize that this reflects a policy choice, and in some cases, I think a policy error.  Bernanke - along with economists like Jonathan Anderson of UBS -- tends to deemphasize the role of policy, or to suggest that this policy shift is a rational response, in various ways, to the 97-98 Asian crisis.   Mike Dooley and his merry band go one step further, and suggest that financing the US is a rational development strategy.

Do check out the debate in the comments section of Macroblog - it almost looks like a Wall Street Journal Econoblog on Bernanke's global savings glut.

As you can see from my overly long comments, I am frustratingly in the middle.  I don't buy Bernanke's explanation for why reserve accumulation in emerging economies surged, and think his thesis needs better explanation for why the surge in (net) private capital flows into China have not led to a fall in Chinese savings.   But I also give Bernanke real credit for focusing attention on the fact that the glut in "savings" relative to investment is primarily found in the world's emerging economies.

I cannot tell you how often I still hear pundits argue that access to US financial markets is the key to growth in emerging markets - even growth in China.   Right now, the opposite statement is more true - the US needs continued access to financing from emerging markets to sustain its own growth.  That's right, financial stability in the US hinges on continued inflows from emerging markets far more than financial development in emerging markets hinges on inflows from the US.  Bernanke, unlike many, recognizes this simple truth - and he also seems concerned about borrowing from abroad to finance home construction:

Because investment by businesses in equipment and structures has been relatively low in recent years (for cyclical and other reasons) and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things. However, in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.

I am glad Bernanke shares this concern -- even if he is not inclined to think it warrants a policy response.


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