What’s at stake: If the private sector continues to save hard even as governments try to borrow less, the risks of a double-dip recession rise. Much of the recent increase in private-sector saving comes from businesses. What explains the rise in corporate thrift, how long will it last, and what policies might reduce it, are the questions the Economist asked to its guest contributors.
Xavier Gabaix argues the increase in saving is insurance against the prospect of bad times ahead. There are at least three basic reasons for firms and households to save a lot. First, they still face a macroeconomic “tail risk” or “disaster risk”, as they perceive that the possibility of some big future economic shock is still high. Under these circumstances, the rational reaction is to save. Second, firms may face tight credit constraints; as a precaution, they keep the cash. Third, anticipating higher future taxes, people save (a Ricardian equivalence result). Gabaix suspects that the first force is the most potent, as it is consistent with the very low interest rates we see (which suggest a high desire to save), and the fact that even firms with great access to capital markets save.
Brad DeLong argues that the macroeconomic tail risk that businesses fear is another breakdown of the credit channel: a situation in which banks dare not lend because they cannot themselves raise funds, and they cannot themselves raise funds because every possible source fears that the bank itself is underwater. This breakdown of the flow of funds through finance as a result of collapses in asset prices that have impaired the capital of financial intermediaries is nothing new. The subsequent flight to quality and fall in investment as businesses seek to raise cash reserves rather than invest in capital is also nothing new. The course of this process in 1825-6 in Britain was studied in 1829 by the French economist Jean-Baptiste Say. Say's successor John Stuart Mill deserves kudos for being the one who came up with the answer to this problem: have the central bank lend to them, and thus give them confidence that if businesses do indeed come to their last resort that the central bank will be there to be their lender.
Hal Varian argues that firms are not investing because they don't see much demand for their products now or in the near-term future. And, of course, we end up with a self-fulfilling prophecy. One possible strategy would be to offer a temporary investment tax credit or accelerated depreciation allowance. Such policies would be popular with the left (which wants more stimulus) and the right (which wants lower taxes).
Mark Thoma writes that the optimistic view is that firms are saving now in anticipation of better times ahead. While they aren't ready to invest yet due to residual uncertainty, they believe there is a pretty good chance that good times are just around the corner. When the good times come, they want to have the funds available to move quickly – there will be many profitable opportunities for firms that can move fast. Thus, the increase in saving is due to speculative balances being held in liquid form so that they can be accessed as needed if and when things improve.
Paul Seabright argues that firms suffered a major shock to their belief that the financial system will enable them to draw on credit when they need it irrespective of whether firms are optimistic or pessimistic about the future. An optimistic firm expecting demand to pick up can no longer expect to borrow easily to meet that demand, so has to build up larger balances than it would previously have thought necessary at this stage of the cycle. A pessimistic firm knows that it's much less likely to be able to borrow to meet a cyclical downturn in demand, so has to build up larger balances. A firm expecting no change must be wondering whether the credit lines it still enjoys will be squeezed as banks rebuild their capital, so has to build up larger balances.
Viral Acharya argues that due to the rise in aggregate uncertainty, the quantity of insurance provision in the economy has gone down, and the weak health of the primary providers of liquidity insurance – the banks – has made things worse. This primarily explains why firms are holding more cash and self-insuring.
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