More on the handouts

I was asked to do this column at short notice today.  I had in mind incorporating a bunch of things I didn’t manage to do. In any event, for the record, here it is.  If I get the time, more on this shortly.

Will the cash splashes lift the economy?

When they were first announced, the Opposition explained that Milton Friedmans permanent income hypothesis showed handouts wouldnt work. Friedman argued that people have this inconvenient habit of thinking before they spend, and they think not of their current income that would be irrational. Rather, they try to smooth their consumption over their lifetimes given their current wealth and their anticipated life income and circumstances.

Friedman understood that his hypothesis was a stylisation of a complex and fraught reality. He wasnt one of those economists who grew so common, who think about the economy as if people really are perfectly rational. He was tilting, sensibly enough, at vulgar Keynesian models which presumed that people had a marginal propensity to consume and would spend some stable portion of any windfall they were tossed by governments.

Still, some who sent Christmas retail spending to a new record amidst all the economic alarm and despondency seem to be behaving with indecent disregard for the permanent income hypothesis. It seems something more prosaic was going on. The handouts were burning a hole in their pockets actually that should be their credit cards but well get back to that.

However the Opposition hardly took a backward step, pointing out that, at just under a billion dollars, the spending surge for Santa was only a small fraction of the nearly nine billion doled out. In fact this was right in line with Treasurys forecast that those on middle and low incomes to whom the money was targeted would let out their belts not immediately but adaptively over the next six months or so.

So whos right? The overwhelming majority perhaps as many as 80 percent of those surveyed tell surveys that theyll save the money often by lowering debt.

Now if theyve deliberately put the windfall in a home loan they are paying off rather than using as a revolving line of credit I expect that money wont be being spent any time soon. And some will have it still sitting in their bank balance. But we have good evidence that people tend to overestimate the efficacy of their good intentions, which is to say they underestimate the extent to which, like Oscar Wilde, they can resist anything . . . except temptation.

So my guess is that, in the ensuring months, more of the money sitting in bank accounts will turn out to fund some minor renovation rescue, a plasma screen, a weekend away. But much of the fate of the handouts depends on the behaviour of people who now have lower credit card debt. Now is their big chance to get off the treadmill.

But you have to wonder what they were doing on treadmill in the first place. Do people who are paying between 11 and 20 percent interest sound that rational to you? Of course, were talking about other people here, not you or me. But lets call a spade a spade. These people are not worthy to even speak the name of the permanent income hypothesis. If they were really, rationally trying to smooth and maximise consumption over their lifetimes, not only wouldnt they have got into this situation, but if they had, theyd have tightened their belts for a few months and escaped the usurers.

So Im expecting most of that money to be spent with the credit cards returning to their equilibrium often maxed out debt levels with six months or so and their owners getting back on the treadmill (why are some bankers already smiling?).

According to a friend in one of the major banks of over two million cards, less than 15 percent are automatically paid off each month. And the Reserve Bank reports that around seventy percent of credit cards accrue interest. Oh and credit card debt rose in December by nearly $350 million the largest December figure since 2003.

So my guess is were on track to comfortably deliver on the Treasurys forecast that around half the cash will splash its way into spending over six months or so. The bad news is that, as other aspects of the stimulus come into play, we need to reverse course and increase saving. We already using lower interest rates to pay off our home loans much faster. Well need that and more, not just to make the recovery sustainable, but indeed to retain the confidence of credit markets, on whose favour we are now dangerously reliant.

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[…] in the Financial Review, Nicholas Gruen had a piece arguing that the December cash splash would be spent over the next few months. So my guess is […]