Growth After the Crisis

• Author: Francesco Giavazzi
• Position: Professor of Economics at Bocconi University, and a regular visiting professor at the Massachusetts Institute of Technology
• Pages: 24-25

Page 24

If the world economy is to recover, a replacement must be found for the newly frugal u.s. consumer

U.S. consumers, for decades the driver of the world economy, appear to have retrenched for the long haul.

To get a sense of magnitudes: U.S. private consumption was about $10 trillion in 2008 and European Union consumption accounted for about $9 trillion. Asian consumption was less than $5 trillion. Before the crisis, U.S. private consumption accounted for about 16 percent of global output. It is not surprising that the economizing by U.S. consumers has pushed the world economy into a deep recession. Nor it is surprising that demand expansion in emerging countries— such as China, India, and Brazil—though on the rise, cannot compensate for the fall in U.S. buying.

Christopher D. Carroll, a Johns Hopkins University economist who has studied the behavior of U.S. consumers for more than a decade, predicts that U.S. households, spooked by the recession, will increase savings to about 4 percent of disposable income—that is, income after taxes. That’s the level at which U.S. households saved in the mid-1990s, before they went on a spending spree that reduced savings to almost zero in the years before the crisis. Disposable income is about 70 percent of gross domestic product (GDP), so a 4 percent increase in the household savings rate would translate into a fall in household consumption of about 3 percent of GDP.

To compensate for declining consumer spending and reduced business investment, many governments have boosted public spending and cut taxes, increasing government deficits in the process. But government stimulus is a short-term prop. Deficits are unsustainable in the long run. Prosperity will eventually require the recovery of consumer and business spending. In fact, even though private demand has yet to recover, policymakers are contemplating how and when to begin to reduce or remove their stimulus packages and shift fiscal balances back toward equilibrium without pushing the world anew into recession (see “Sustaining a Global Recovery” in this issue).

Page 25

How will the world replace a reduction in global demand as large as 3 percent of U.S. GDP when governments begin their inevitable fiscal consolidation? That is the major issue confronting policymakers and economists.

Many observers think that the answer, in the medium term, is an increase in domestic demand in China. But...