Americans need to save more so that we can finance investments in the economy instead of borrowing the money from other countries (thereby necessitating that we earmark some of our incomes to pay them back with interest later).   Granted this increase in saving will slow the recovery but it does not necessarily undermine the effectiveness of the stimulus bill.  Without the stimulus bill things would simply be worse.  It’s true that there’s a theory that says that consumers save more when the government stimulates the economy because they believe their taxes will go up as a result of the stimulus so they set money aside to pay the tax collector. If this theory were true, we would have to conclude that the stimulus caused the higher savings and thus has had little or no net effect. But ask your friends and relatives why they are saving more and very few will mention the stimulus bill and higher taxes as a prominent reason.  They are saving more, in my view, because of uncertainty about job prospects, the stock market, and the value of their homes. I’m doubtful that the savings rate will go a lot higher or remain at elevated levels for very long because I think we have become a credit-based economy in which a culture of savings has lost its sway. If you look at each birth cohort’s savings rate you can see a secular decline that to my way of thinking is more about culture than economics.        

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Martin Feldstein and others predicted that the tax-cut component of the fiscal stimulus package -- precisely because much of it would be saved --  would have much less expansionary bang-for-the-buck than the spending component of the stimulus package.     (Bang the for the buck in this case could be defined as demand stimulus divided by budget cost.)     But President Obama had to get those last three (Republican) votes in the Senate, and those three Senators insisted on raising the tax cut component and lowering the spending component.   Their motivation presumably was to mollify their fellow Republicans, many of whom still claim that ONLY tax cuts provide stimulus, and that spending does not, which is even more extreme than the claim that a tax cut creates stimulus equal to spending.     After the failures of the Bush tax cuts (and Reagan's before him), I don't know if any economists still cling to such "supply sider" notions -- or indeed if these congressmen woudl be able to state their logic.    But I think the Feldstein prediction was borne out.

Fortunately, the majority of the stimulus package took the form of increased spending, much of which has yet to come.     None of this is to deny that efficiency is an important consideration, and cost-benefit calculations should enter into the choice of both what kind of tax cuts and what kind of spending increases are adopted.   But if it is short-term demand stimulus we are after, and we are, then government spending gives more bang for the buck than tax cuts.   

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I reject the basic premise of the question. Neither the 2008 nor the 2009 stimulus package has “failed” or been shown to be a failure.

The most recent business cycle expansion reached a peak in the last quarter of 2007. Since that time the number of payroll jobs has shrunk without interruption and total U.S. output has fallen 3.7%. The drop in private personal income was even faster. It fell 4.4% in the six quarters after the end of 2007, a decline of more than $500 billion at an annual rate. At the same time, the net worth of American households fell more than $12 trillion, or about one-fifth.

In the face of the sharp fall in private income and steep dive in household net worth, personal consumption expenditures fell just 2% from the beginning of the recession through the second quarter of 2009. One reason the drop in personal consumption was so small was the massive swing in household tax liabilities and government transfer payments. This swing was partly the result of two stimulus packages passed in 2008 and 2009. In the six quarters since the end of 2007 personal tax payments and social insurance contributions fell more than $450 billion at an annual rate, or more than 18%. Transfer payments to households increased $382 billion, or 22%. In combination these two items added more than $830 billion to Americans’ personal disposable income. 

Remarkably, Americans’ disposable income increased more than 3% between the last quarter of 2007 and the second quarter of 2009. This represents a sharp contrast to the 3.7% fall in income from private sources. To be sure, the personal saving rate has increased as households have attempted to rebuild their wealth and reduce their indebtedness. Still, the increase in personal saving has not been nearly large enough to offset the full effect of lower taxes and higher government transfers. Household consumption has fallen in the recession, but it fell much more slowly than the drop in wages, business profits, and income from interest and dividends.

The notion that the stimulus package failed is based on a very unrealistic benchmark. The assumption of stimulus critics seems to be that for the package to succeed household consumption must remain constant or even rise in the face of sharply lower private incomes and household wealth. How realistic is this expectation? Not very. My interpretation is that the massive swing in taxes and government transfer payments, produced in part by the stimulus packages, moderated the fall in household consumption that would otherwise have occurred. The stimulus packages did not end the recession, but they reduced its severity.

Critics of the government’s stimulus measures seem to forget another thing. The goal of these programs is not simply to provide a counter-cyclical boost to consumption.  An equally important goal is to help offset the income losses experienced by the victims of recession. The hardest hit victims include laid off workers who have suffered long spells of unemployment and the loss of health insurance. For the first time ever, the federal government has done something to help workers pay for continuation of their health benefits after they lose their jobs. When critics of the stimulus package pronounce with mock sorrow the program has been a total failure, the rest of us should remember an important point:  This “failed” program has delivered timely and critical relief to millions of families hurt by the recession. Most of them live more comfortably and consume more goods and services than would have been possible without the stimulus package.

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Charles Calomiris and two co-authors dispute the idea that house wealth (or its loss) has or  would have a sizable effect on consumer spending. The NBER paper is available by subscription here, but a good summary is available to all here.

Updated at 12:36 p.m. on Aug. 3.

As I pointed out in a prior posting, household savings from disposable income is rising to replace lost wealth. The dismal prospects for economic growth and for continuing rises in the stock market and in commercial property, along with the slow growth in employment that will accompany the meager gains in income and wealth, will keep personal savings high. The increases in house prices, in contrast, will have little effect on savings, since housing wealth effects on consumption are close to zero (see the recent article on this topic by Stanley Longhofer, William Miles, and myself). The dismal prospects for economic growth and consumer wealth looking forward reflect a combination of anti-growth government policies, including the expiration of the Bush tax cuts, wasteful "stimulus" spending, cap and trade taxes, likely healthcare taxes, etc., and continuing limited credit availability for small businesses. The prospects of high taxes and limited credit will especially affect small business investment, an important engine of growth that will be muted during this recovery. Savings will remain high and that will dampen near-term growth in demand. But that is not the major medium-term concern in the economy; anti-growth government policies affecting both supply and demand are much more important than the additional drag on demand coming from higher personal saving.

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