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Welcome back. It’s the last day of August, which means that wonderful, all-purpose explanation for anything that happens in financial markets — “it’s August, everyone is on vacation, there’s no liquidity” — is set to expire. Make sure to get some use out of it while you can. Email me: [email protected]
Is an excess of rich people, not of middle-aged people, what depresses interest rates?
My expectation that nothing of interest would happen at the Federal Reserve’s Jackson Hole conference turned out to be wrong. Fed chair Jay Powell’s speech was boring, sure, but three academics redeemed the proceedings by presenting a paper investors would do well to read.
They argue that the primary force driving down interest rates is not demographic change, but income inequality. This is important for investors, because the demographic trend that has (in theory) put pressure on rates is set to reverse, while the trend towards greater income inequality looks like it’s locked in place.
Atif Mian, Ludwig Straub and Amir Sufi agree with partisans of the demographic view, such as the economists Charles Goodhart and Manoj Pradhan (whose view I have spent fair amount of space on here), that a key contributor to falling rates is higher savings. Savings chase returns, so when there are more savings and the same number of places to put them, rates of return must fall.
Mian, Straub and Sufi disagree, however, about why there are ever more savings sloshing around. It is not because the huge baby-boom generation is getting older and saving more (a trend that will change direction soon, when they are all retired). Rather, it’s because a larger and larger slice of national income is going to the top decile of earners. Because a person can only consume so much, the wealthy few tend to save much of this income rather than spend it. This pushes rates down directly, when those savings are invested, driving asset prices up and yields down; and indirectly, by sapping aggregate demand.
Why doesn’t all the cash that the rich push into markets get converted, ultimately, into productive investment, either at home or abroad? Tricky question. For present purposes it is enough to note that this is not happening — the savings of the American rich reappear, instead, as debt, owed by the government or by lower-income US households. (In another paper, MS&S have pointed out that this means the high share of income going to the rich hurts aggregate demand in two ways: the rich have a lower marginal propensity to consume, and governments and the non-rich are forced to shift dollars from consumption to debt service. Economically speaking, high inequality is a real buzzkill.)
MS&S prefer the inequality…
Read More: The rich get richer and rates get lower