The tricky bit of getting consumers to spend

This article appeared originally in Gulf News: link to original article

I  would personally like to see cash being thrown out of helicopters like many economists have been arguing as the ideal hypothetical solution to the current deflation, stagnation, etc. People might anyway take the cash and keep it at their homes.

In Japan, recent higher sales of safe boxes have been reported. A few years back, $50 billion (Dh183.65 billion) was believed to be stored under mattresses in Argentinian homes. If anything, this shows that the problem of not spending has been around for some time. But whether or not this is the main driver of deflation, and whether it boasts a causal relationship with the current negative rates are different cases altogether.

So people are not spending money, and companies are hoarding cash for no obvious reason. Why? Before negative rates, there were back-and-forth arguments on raising minimum wage as part of the solution. If you don’t have the money, you won’t spend it, right? Sounds very simple.

The case is a bit more complicated than that. When trying to dissect the not-spending problem, I came up with four main reasons:

1. Flat wages even in economies with humble inflation rates.

2. Existence or increase of consumption taxes or any other of the same nature.

3. Fear of another crisis.

4. Negative rates.

The first reason was actually one of the indicators that a financial crisis was looming around 2007-08. Adjustable loan rates — ones that change later on as per market conditions — and flat wages meant that people could not refinance and would so default. The same could be said nowadays.

Even with fixed rates instead of adjustable ones, flat wages mean that people cannot refinance to lower their monthly loan payouts. Hence, whatever current household financials that they maintain will remain unchanged.

People might actually be encouraged towards saving more since their current economic prospects do not look good. Japan is a typical case-in-place on the downside of having a consumption tax. I would like to believe that Japan could have moved closer to its inflation target if it did not increase its consumption tax from 5 per cent to 8.

This is the classical consumer-versus-government spending. Government raises revenues from taxes to then spend that money in purchasing its own bonds back from banks and companies. Now if the money did find its way back to consumer pockets, which is why Prime Minister Shinzo Abe has been pushing for higher minimum wages, then that could have been attained.

However, companies keep the cash and banks are being charged for their deposits. So consumer spending or government spending?

The third reason is psychological. If you keep warning people of a looming crisis, and that the world is barely recovering, then you are giving people every single reason not to spend money. This can be seen via revisions of growth rates and economic outlooks.

Then, when negative rates on deposits were introduced, people were expected to withdraw their cash and spend it. Instead, people resorted to storing cash at homes. Others would probably find alternative options such as low-yielding bonds to park their cash.

The third and fourth reasons taken together could partially explain why negative rates aren’t working as forecasted. When examined closely, spending cycles are not complete. This is evident from the example of flat wages and consumption taxes, and from the case of negative rates and their psychological association.

So what could be done to fix this? The straight forward solution would be to increase the minimum wage and to lower consumption taxes. Though the former has been randomly adopted on a micro level, macro-level action by governments could perhaps break the deflation taboo.

The last thought that I want to leave you with: should corporate taxes be used as a tool to influence minimum wages?