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Case: Not Saving Enough
What is the size of the federal deficit? To find out the public debt today to the penny, visit the Department of the Treasury, Bureau of the Public Debt, or review the "U.S. National Debt Clock." Reload the page to see how quickly the debt is changing.
The relationship between aggregate expenditure and real GDP is not a simple one, but it is extremely important. There are two kinds of spending: autonomous and induced. Autonomous spending is any spending that is independent of the level of income. In our model, autonomous spending includes investment spending, government purchases, export spending (and sometimes net exports), and a component of consumption spending. In the income-expenditure model, the consumption function intercepts the vertical axis above the origin. This means that real GDP equals zero, yet expenditures on consumption are positive. This amount of consumption spending is autonomous spending. (If C = a + bY, the autonomous portion is a.)
Induced spending is spending that occurs because of changes in the level of income. When there is a "marginal propensity to ... ," there is induced spending. Changes in income cause changes in spending. When autonomous spending increases, income increases. But the increase in income (real GDP) causes changes in induced spending. So the relationship between spending and income is complex.
Question to Think About: Is saving autonomous or induced?
Multipliers and Public Works
The principles behind the multiplier are at work in many situations. If Honda builds a factory in a community, many jobs are created and spending in the area increases. The effects are more than just the immediate effects of building the plant and hiring people to work in the plant. The higher incomes of the people who work there increase their spending, which causes the incomes of others to increase, thus increasing their spending. The multiplier is at work.
It is also possible for multiplier effects to be exaggerated. Suppose a local sports team threatens to move unless it gets a better deal with respect to renting the local stadium. Newspapers are likely to report that the "economic impact" of the loss of the team would be fairly large. The impact would include the loss of salaries by those who work for the team and at the stadium on game days. It also would include the loss of dollars spent at the game on tickets, merchandise, and concessions. A multiplier is estimated and a total loss to the city is calculated. But this analysis would probably exaggerate the influence of the team on the local economy. Attending a sporting event can be thought of as entertainment. If the team was not in the area, people would do something else: go to a movie, eat dinner at a restaurant, go to the zoo, or any number of other things. If most of the money spent at the game would have been spent in the local area anyway, the economic impact of the team is reduced.
Question to Think About: If many people who attended the games traveled a long distance, would the multiplier associated with the team be higher or lower?
Consumer spending in the largest component of aggregate spending, accounting for about two-thirds of the total. Consumption depends primarily on household income. But at any given income level, the willingness to consume depends on several factors including household wealth, the interest rate, and consumer expectations. Look what's been happening in Japan. A nine-year stock-market slide has cut the average value of shares by two thirds, taking a big bite from the wealth of Japanese households. What's more, many Japanese banks are in trouble because of real-estate loans that soured as the country's booming real estate market collapsed. The sharp reduction in consumer wealth coupled with an erosion of consumer confidence in the future have cause Japanese households to try to save more and consume less. Thus, their consumption function has shifted down and their saving function has shifted up.
The drop in consumption has reduced aggregate demand, triggering Japan's worst economic slide in decades. Retail sales dropped 3.7 percent in July 1998 from a year earlier, the 16th monthly decline in a row. In July, for example, car sales dipped 6.4 percent, and electronics purchases 4.8 percent. Japanese output has now declined for three quarters in a row.
Aggressive efforts by bank regulators to clear the books of bad debts would likely result in the insolvency of some major banks. Such a move would help the long-term prospects for the economy but would cause greater instability in the short run. Japan, the second largest economy in the world (after the United States), is, by far, the largest economy in Asia. A weakened Japan hurts the already troubled economies across Asia, since Japan is a customer for their exports. (Updated 9/2/98)