David Leonhardt notes the rise in the household saving rate that is one of the main causes of the current downturn. While he notes the excessive flow of credit prior to the downturn, it would have been helpful to describe the mechanism more clearly. The Federal Reserve Board either could not see, or chose to ignore, an $8 trillion housing bubble. Economists know that people spend based in part on their housing wealth. The usual estimates of the wealth effect are between 5-7 cents on the dollar. This means that the bubble led to $400 billion to $560 billion a year in additional annual consumption. This was not the result of spendthrift consumers, it was the predicted response to the bubble. The graph that Leonhardt includes actually understates the increase in the saving rate in recent months. There was an extraordinary rise in income relative to output measures of GDP in 2006 and 2007. This was almost certainly attributable to capital gains in the stock market showing up in the income measure. If we assume that the output side measure of GDP is more accurate than the input side (a generally held view among economists), then income and the savings rate were actually lower in 2007 and the first half of this year than saving data show. This means that the savings rate has jumped by a larger amount in the last six months than the standard show.
--Dean Baker
