walkitout (walkitout) wrote,
walkitout
walkitout

When I'm Wrong, I'm really, really wrong

I posted this recently: http://walkitout.livejournal.com/1167823.html

Turns out my education failed me! http://en.wikipedia.org/wiki/Thesis,_antithesis,_synthesis lays it out clearly. Hegel mentioned it once, and attributed it to someone else, and it isn't what I was taught any way. Pity!

And I've encountered the Permanent Income Hypothesis before -- I just was so busy being mad at the stuff around it that I failed to notice it. Back in 2008-2010, when we were arguing about stimulus, what kind, and whether it could possibly help, one of the arguments against stimulus was the Permanent Income Hypothesis. The PIH says: people will spend according to their expected lifetime income, smoothed out. So if you give them extra in a downturn, they won't spend it.

It's such a crazed idea, it's sort of hard to wrap one's brain around it. If you're trying to figure out whether you're going to pay the heating bill or buy food, PIH really just cannot mean _anything_ to you at that point in time, and if someone gives you a $300 check, or reduces your contribution to unemployment insurance or whatever, you will spend that money. Also, while we're working our way down to 1 person = 1 household, we are not there yet and, honestly, we won't ever be there because children aren't allowed to live by themselves. Given the turnover in household composition over time, I just cannot even figure out _whose_ permanent income to calculate by! Me living with my parents? Me with my first husband, working at DEC? If I thought of it that way, should I have been spending money from the job he didn't have yet, and would only get after our divorce? Me living with a boyfriend, sharing bills the way unconnected roommates do? Do I calculate my spending allowing for him to move out? Expecting to be able to replace his contribution to the rent? Me living entirely alone in my own place at a startup that I knew I wasn't going to last at -- and getting stock options that I spent some time nearly every day speculating about the possible future value of?

There is _no_ moment in my life where I could have calculated anything resembling the permanent income that was supposed to drive my consumption decisions. So how _did_ I decide how to spend my money? After all, this thing is supposed to be one of those individuals acting individually collectively create an outcome. At no point could I do the sort of 4 year average lookback to predict the future which Friedman envisioned: my income changed too dramatically from year to year even when I was employed. Post retirement, I had a pile that I needed to somehow turn into an income stream I could live off of (hopefully until I died at a very advanced age). You'd think at this point, I would have been able to create a predictable permanent income, but I know how annuities and bond ladders work and I was never able to commit to them. I accepted massive volatility in exchange for the potential to make a whole lot more, with the understanding that I was young enough to go back to work for another ... 30+ years, with a high-demand degree and experience that wasn't too far out of date.

Here's what I did, and I think it's what most people do. When you're young, you just don't have any money, and you may be in hock up to your hairline, depending on your educational decisions and family capacity to pay. Then you get a job, and you try to extricate yourself from the debt. In order to do so, you try to reduce your costs as low as possible: live with parents or friends, make your own coffee and lunches, find the cheap places to eat or be entertained that taste good and feel like a treat. Get better at cooking. Swap clothes with friends to get something new, shop consignment and thrift and sales. After some number of years, you hopefully get the debt under control, maybe pay off your car and start thinking about family formation. Then you descend into the chaos of trying to reconcile spending approaches across the new family and if it works out okay, start saving for future needs: a downpayment on a condo or house, savings for a rainy day, savings to get you through parental leave when you have a kid, and if you have the kid, then a whole new set of bills to deal with, including saving for their college. Meanwhile, everyone around you is screaming about saving for retirement, because all the advice givers are 15-40 years older than you and that's what _they_ are wishing they'd done something about when they were younger and they are hoping that if they yell at you, you'll get it right. But that's just stupid, because if you saved all your money for retirement, but failed to pay off school debt or keep your car running or pay for your kid and your kids education, your own retirement ain't ever gonna happen, because you are putting pressure on a vein while bleeding out through your femoral artery.

If, and I am not prepared to grant this, but IF there is any kind of delay in the impact of income changes on spending patterns, it is NOT because of intertemporal optimization. It is because you sign for the student loan, car loan, house note, etc. and YOU HAVE TO KEEP MAKING THE PAYMENTS. So whenever you have some money that is not pre-allocated to any of the pre-determined commitments, you hoard it, because you know bad shit will come someday (probably soon), and YOU HAVE TO KEEP MAKING THE PAYMENTS. You stop making the payments, and they balloon and/or someone comes and takes the thing away from your or kicks you out of it or changes a setting in your account so your car won't start the next morning. You have to have a LOT of certainty in your life to be willing to just spend new money. (Or you have to be stuck in cash-only hell, which is a whole other thing, and there, you'll just spend whatever you have.)

When Paul Krugman wrote (in a shockingly accepting way) about PIH (I am still surprised I didn't notice this years ago) and then worked around the edges of it to explain how stimulus would still work, Krugman maybe missed an opportunity (probably not -- he's a very practical man and I am an idealistic ass) to point out how PIH is more about payment lag (and anticipated missed-payment-risk) than it is about intertemporal optimization of spending. He definitely noticed and emphasized that anyone who was having trouble paying immediate bills would spend every damn dollar you could send their way Right Now.

Finally, to the extent that anyone can successfully plot out their arc of income and then plan their spending accordingly, I would argue that they must exist in a context of other incomes and piles of wealth upon which they can rely: parents and grandparents who pay for college, who pony up for the down payment on the first house, who send you off to Europe to go backpacking, who can be relied upon to keep your car running during those crucial first few years post-college (or if college doesn't work out for you) that you have a job and you can't afford really any life at all. This is not the crowd that most needs stimulus in a downturn.

In case google is not your forte, here are some examples of Krugman talking about PIH in the context of the stimulus debate:

http://krugman.blogs.nytimes.com/2008/01/21/stimulus-issues/
http://krugman.blogs.nytimes.com/2009/01/31/another-temporary-misunderstanding/
http://krugman.blogs.nytimes.com/2010/09/15/the-economics-of-high-end-tax-cuts/
http://krugman.blogs.nytimes.com/2010/08/05/tax-cuts-and-the-economy/
http://krugman.blogs.nytimes.com/2011/08/05/anti-stimulus-politics/
http://krugman.blogs.nytimes.com/2013/03/19/demystifying-taylors-confidence-fairy-wonkish/

There are probably more.

There's actually another theory out there to account for lag in response to stimulus. Well, there's a bunch, notably, that there actually isn't much of a lag at all and Friedman monkeyed with the numbers to suggest there was one because he was opposed to Keynesian style intervention. But I digress. One possible explanation for why not-totally-broke people will bank a wad of money they get handed, rather than just spend it right away, is because past a certain point, ESPECIALLY IN A DOWNTURN, there are a lot of forces _against_ consumption. First (and this is the most important), if you see a bunch of people around you lose your jobs, the possibility that you, too, will lose your job seems a lot more salient. Second, if none of your friends can afford to spend their money, it's a lot less fun to spend your own. If you usually have lunch out with your buddy, but she doesn't have a job any more, you'll probably just bring your lunch or get something cheap to go. If you usually go out for drinks with your friends after work, but their spouses are all working shorter hours, then you probably won't be going out for drinks with your friends after work. Especially if they had to end their child care arrangements because they couldn't justify that expense when there was an underemployed adult in the house. And on and on and on. If your friends are about to lose their house, you aren't going to spring for a new luxury car. There were a ton of articles in 2009 about how it was suddenly Uncool to flaunt it, and super cool to show your thrifty side, even if the downturn had no practical impact on money in the door for you personally.

And here's the real kicker. Even there's been no job loss in your family and you have savings and you have a retirement fund and you have investments and you own your home(s). Even if your credit is basically perfect, in a really bad downturn, there is a period of time when you would _love_ to upgrade from the house you bought when you didn't have kids to the house you want now that you are done making babies (and you realize that they are both special needs kids and you don't want to live in New Hampshire any more. Yeah, this is personal.). You found your house. You could sell stock and buy it outright, but now is not a great time to sell stock. You could _easily_ afford to make a big down payment and get a mortgage for the rest and pay the mortgage out of short term savings for the time it took for things to get better, the stocks to recover, a new job to be found after a hypothetical job loss in the future. But good luck getting a bank to help you out with that new consumption, because no one is loaning anyone money for at least another few months.

Banks probably _do_ sort of obey the PIH. But not people.
Tags: economics, politics
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