In an interview format with Aaron Steelman. Pointer from Timothy Taylor. Interesting throughout. A few tidbits:
people don’t spend the money the week before it shows up — they spend it the week it shows up. And it seems like you’re going to have a lot of difficulty quantitatively fitting that little foresight into a life cycle model unless people are often literally liquidity constrained, absolutely at their debt limits.
…
What equilibrium supports high-fee mutual funds, index funds, and so on, and how does that change the flow of funds between the corporate and household sector and the pricing of risk?
a high propensity to consume correlates with low liquidity, which is useful for theorizing but also presents a little bit of a chicken-and-egg problem. Is it different preferences, objectives, or behavioral constraints that are causing both the low liquidity and the propensity to spend, or is it the low liquidity that is causing the lack of planning and high spending responses? So for many purposes, what I take my findings to mean is that the buffer-stock model is a quite reasonable model with one critical ingredient. The critical difference relative to the way I modeled households in the 2002 paper with Gourinchas is that I think there’s much more heterogeneity in preferences across households. While in that paper we looked at differences in preferences across occupation and industry, I think there’s just much more persistence in heterogeneity in behavior, consistent in the buffer-stock model with differences in impatience.
There is a significant portion of the population with above-median income and close to zero saving. I think it is hard to tell a story that explains that in terms of rational behavior. Remember, we are talking about a lot of people, not just a few random exceptions.
Broadening your definition of “savings” to include entitlements might help. We can then argue about whether or not it is rational to call those programs savings.
Indeed I personally have no idea how to estimate my future medical costs in retirement. I am also uncertain how much of thoses costs I will personally pay. How can anyone plan for the future when costs are completely unpredictable?
Cash usage fees, the generic ATM fee is about 2.5%. That is the ten year fixed rate, and a rigged rate. Since the system is designed to also manipulate consumer prices, the consumer is better off having low savings and high inventory. The dollar does not work well these days.
There are some reasons, expectations of vvery stable future incomes, expectations of great uncertainty of whether you will be alive and healthy to spend it, or just converting income into assets, but time preference would be a strong choice.
Why don’t people do consumption smoothing? Start with a couple basic questions — do you have a stable form for storing wealth? Is it secure from theft? It is only recently in evolutionary history that the answers have been yes for even a minority, so it’s not surprising that saving and smoothing don’t come all that naturally.
Then, move on to culture. Do you have friends and relatives who experience periodic financial emergencies and feel entitled to ask others for ‘loans’ at those times? And will you feel an obligation to oblige them if you can afford it (and risk community disapproval if you refuse)?
Next, if somebody from your culture meets you for the first time and notices that you drive an ordinary, older model car and wear non-name brand clothes and shoes, will they immediately assume A) that you’re sensible? or B) that you’re a loser? If they later find out you actually do have wealth will they then A) be impressed by your self-restraint and financial responsibility? or B) conclude that you’re a dull weirdo with no taste?
Consider worst-case scenarios. Just how risky is running out of money? Is there any chance that you’ll literally starve? And is there great shame in accepting public assistance? For most of human history, the answers to those question were ‘yes’, but not any more. The downside risk is much less.
Lastly, if you’re low-income and reasonably believe you’re going to be that way for the duration, what sounds better — a life of ‘smooth’, secure, stable poverty? Or a life punctuated by financial emergencies but also a few brief, wild periods of splurging and feeling like a rich person? Is it really a surprise that a lot of poor people choose option #2?
Indeed
You’ll note that a lot of these answers are heavily dependent on culture, and they haven’t always been the same even within our own culture. How does “Lives of the Rich and Famous” on TV change your perceptions of what is appropriate spending?
America in particular really seems to chew up the culture of everyone on the left half of its bell curve. Even most new immigrants in that profile, whatever virtues they bring with them, assimilate to new destructive American norms once here a generation. What’s going on in the culture in the lower half is a particularly vexing problem that will become more and more relevant as the bottom half grows.
Although I’ve heard many people talk about the problem (Putnam, Murray) I haven’t heard a lot of good solutions to this problem. To the extent such solutions are even possible, I suspect they would require more personal restraint by the right half and social paternalism of the bottom half. That’s difficult and unpopular. It also grinds a lot of ideological gores.
Can we start by not subsidizing it?
“How does “Lives of the Rich and Famous” on TV change your perceptions of what is appropriate spending?”
I don’t believe that’s really much of a factor — or at least not a new one. The lives of the rich, beautiful and powerful have been the stuff of popular entertainment basically forever (at least since Homer). And research shows that peer groups, not celebrities, are the important influence on people’s spending decisions. People are trying to keep up with their neighbors, not the Kardashians.
“Even most new immigrants in that profile, whatever virtues they bring with them, assimilate to new destructive American norms once here a generation.”
That’s not universally true by any means. East and South Asian immigrants seem to do very well (better than natives, in fact) far beyond the first generations. But yes, American working class culture does seem to be fraying in a lot of ways.
“To the extent such solutions are even possible, I suspect they would require more personal restraint by the right half and social paternalism of the bottom half. That’s difficult and unpopular.”
I don’t think personal restraint by the wealthy has anything to do with it. The out-of-wedlock birth rate has not skyrocketed among the lower classes because of the spending habits of the wealthy (who, as Murray points out, have preserved stable families and other traditional mores of self-restraint and deferred gratification to a far greater degree).
But I don’t have any great solutions either. By historical and global standards, America’s poor are quite wealthy, but that hasn’t prevented the problems. But we have to keep in mind that culture is emergent — there is no government power, no ‘we’ who can decide to change it, even if we knew what changes to make.