The small Propensity to Consume by Capital Income… and the Fall in Labor Share
James Kwak at Baseline Scenario writes about wealth inequality and supports systematic redistribution. And our own Steve Roth wrote on this too here at Angry Bear.
What is the propensity to consume by capital income? Well, for every dollar of capital income, roughly 18% is being spent on consumption. (15% effective tax rate, 67% savings rate)
What is the propensity to consume of labor income? Well, for every dollar of labor income, roughly 85% is being spent on consumption. (10% effective tax rate, 5% savings rate)
So, what does it mean in an economy with a real GDP around $16 trillion that labor share of income has fallen by 6.8% since 2007? Well, 6.8% of %16 trillion is $1.088 trillion. If that money was in the hands of labor income, $925 billion of it would be spent on consumption. However, that money is in the hands of capital income, so only $196 billion of it is spent on consumption.
The difference is $729 billion less being spent on consumption.
Brendan Greeley and Matthew Phillips at Bloomberg Businessweek tell us what the current shortfall in potential GDP is according to the 2007 CBO projections …
“The CBO’s own data show this as a current output gap of $754 billion.”
The fall in labor share looks to have accounted for almost all of the fall in potential output.
Update note: Real GDP is made up of consumption, net government spending, investment and net exports. Yet, total real GDP is split into labor share and capital share. Thus consumption, net government spending, investment and net exports are all contained within the split between labor and capital shares. An increase in capital share lowers consumption and is hopefully made up for in increased investment. Investment was $2.639 trillion in 1st quarter 2007 (real 2009 dollars). It was $2.656 trillion in 4th quarter 2013. An increase of $17 billion in real terms. So increased capital share did not lead to a significant increase in investment. The rich are richer, but real GDP has fallen.
The propensity to consume from capital gains is also inferior to the MPC from money transfers like heli drops.
Monetary policy centered on adjusting the fed fund rates in order to increase asset prices doesnt translate into increased spending as much as an increase income or money transfers.
The fed could directly interact with the broad public increasing money balances to the to achieve its inflation or ngdp goals instead of hoping on the wealth effect and the credit channel to be efficient.
Dannyb2b,
Thumbs up on your comment.
Also people that are heavier in debt consume less. Therefore the fed creating money on a non debt basis directly with the public will realize a higher MPC per expansion of money because of lower debt loads.
For the non-economists I am considering adding a second rule of economics to the first law which is, nothing happens until someone buys something.
And the second is:
“Money is like manure. It’s not worth a thing unless it’s spread about, encouraging young things to grow.” Thornton Wilder
Which strangely enough, goes back to at least Francis Bacon almost five centuries ago.
What is the propensity to consume by capital income? Well, for every dollar of capital income, roughly 18% is being spent on consumption. (15% effective tax rate, 67% savings rate)
Wait — Just last week, I was told: “there’s no evidence that those with wealth or high incomes save any more out of the income that they derive from the production of new goods and services than anybody else”
. – See more at: http://angrybearblog.strategydemo.com/2014/03/did-the-fed-cause-the-great-recession.html#sthash.JXQeyVUh.dpuf
Am I misinterpreting, or do you subscribe to some version of the underconsumption hypothesis? It was suggested that this is “a highly implausible theory.”
Cheers!
JzB
Hi JazzBumpa,
Labor income is made up of high incomes too. I separate out capital income which is taxes differently. and the government gives a measure of capital income compared to labor income.
Capital income contains business profits among other things. There is a different savings rate compared to labor income.
Where did you hear that capital income has low savings rates like households?
One thing to keep in mind is that when people show the circular flow of the economy between households and firms, sometimes you will see a disclaimer that it is not actually correct because not all income is directed from firms to households. Much income stays within firms.
But if you say that all income is saved at the same rate, the numbers from the NIPA tables will never make sense. Capital income has to save at a different rate.
I’m sorry, but isn’t the loss in the labor share 6.8% of 63.43%, the labor share GDP on 2007-01-01? That would be
0.068 × 0.6343 × 16 trillion dollars = ~690 billion dollars for the dollar amount of lost labor share