How to Spend and Save at the Same Time
February 11th, 2009 . by economistmomDavid Leonhardt has a nice column in the New York Times today, explaining how this is possible–that the government could actually get us to spend more (for stimulus in the short term) and save more (for growth over the longer term):
It’s your fault. Part of it is, anyway. You, the American consumer, spent too much money. You bought too much house, took on too much debt and generally lived beyond your means. Your free-spending ways helped cause the worst financial crisis since the Great Depression.
And now you’re going to have to do your part to end the crisis. How? By spending. Enough already with the saving that many of you have suddenly begun doing. This very moment, Congress and President Obama are preparing to send you a tax rebate, to inspire you to stimulate the economy. So go out and stimulate. Spend as if the future of your country depended on it.
John Maynard Keynes, the great 20th-century economist, would have appreciated the apparent absurdity in these mixed messages. He coined a phrase, “the paradox of thrift,” to point out that what was rational for an individual during hard times — saving money — could be ruinous for an entire economy. Eventually, many of the savers may end up out of work because everyone else is saving, too.
It’s enough to make you wonder what exactly you’re supposed to do. At his news conference on Monday night, Mr. Obama was asked directly whether people should spend or save their rebate checks. He ducked the question.
Fortunately, though, it has an answer. There are a few ways to help both your own finances and the country’s.
The first involves figuring out how to spend money now to save money later — which can lift the economy today and help individual households cope with their battered finances in the long run. The second involves realizing that Keynes’s paradox isn’t ironclad. In a financial crisis, when banks may need capital as much as retailers or restaurants need business, many people can save without guilt…
David explains that it’s not that we’re already proficient at this “saving” thing (what I’ve called “living within our means”). It seems to run against our American nature:
Psychology-tinged economics — that is, behavioral economics — has taken off over the last two decades, and one of its central findings is that most people do not do a good job of planning for the future. They aren’t nearly as nice to their “future self,” as economists say, as to their “present self.”
They eat just one more doughnut and put off exercising until tomorrow and tomorrow and tomorrow. They fail to set aside enough for retirement. Again and again, they choose a bird in the hand — be it dessert, convenience or a little extra cash — over three or four in the bush.
And he provides some great real-world examples of how to do it–this spending and saving at the same time:
A programmable thermostat, which adjusts the temperature when people are out of the house or asleep, can cost as little as $50. For less than $1,000, people can buy the thermostat, as well as hire a contractor to fix leaks and replace their light bulbs with more efficient ones. In either case, the spending often pays for itself in just a year or two.
“There is a difference between consuming and investing,” says Ken Ostrowski of McKinsey. “And energy efficiency falls more into the category of investing.”
I asked behavioral economists for some other examples, and they helped me come up with a nice little list. Parents of young children can join Costco and make up their membership fee with just a few months of diaper purchases. Drivers can inflate their tires, change their air and fuel filters and start getting better mileage. Frequent book buyers who don’t mind screen reading can buy the new Kindle. It costs $359, but most new books then cost less than $10.
Families who shop at rent-to-own stores, which charge ridiculous interest rates, can temporarily pare back and then buy furniture or electronics outright…
Well, just make sure you don’t charge these wise purchases on a high-interest credit card–lest you sabotage that “paying off over the longer run” goal. Borrowing the money to purchase those wise investments only makes sense if the return on the investment exceeds the interest rate paid. Otherwise an otherwise good investment (in and of itself) becomes a bad, deficit-financed investment. It gets back to the basic principle: don’t buy stuff you cannot afford (even if they’d be smart purchases for people who can afford them).
And this idea of spending now being ok for even the longer-term outlook, as long as there’s likely to be an eventual payoff even net of any financing costs (if deficit financing is even necessary) applies to the recovery package as well:
The ideas here don’t apply only to individuals, either. They apply to the stimulus package as well. The federal government is set to spend $800 billion to stimulate the economy. Much of that money will necessarily go to tax rebates, unemployment benefits and other programs without much long-term benefit. But $800 billion is a lot of money. And the best forms of stimulus are the ones that take effect quickly and bring a long-term payoff. That can mean tax credits for home weatherization or money to pay for the installation of computerized medical records — two programs that are still in the stimulus bill.
Let’s hope we know what we’re doing in pursuing this massive amount of deficit spending in the name of not just short-term stimulus, but also longer-term “reinvestment.” For those policies and projects encouraging longer-term economic growth to pay off, on net after the compounding interest costs associated with the added debt, these (re)investments, based on their own merits, are going to have to pay off big time.
