Of mice and maximin

Gabriel summarizes the debate on fiscal stimulus and comes down on John Taylor‘s side (good choice). Those checks we got in the mail from the Feds didn’t increase aggregate demand; while take home pay went up, consumption didn’t. People, on average, put that money in savings (e.g. paid down their credit card debt).

This conforms to standard economic theory, but not, by the way, our cherished models ((Won’t anyone defend Keynesian fiscal stimulus?)). People that win a lottery will tend to put most of their winnings in savings and only consume a small bit at a time because they know its a one time windfall. On the other hand, people who get a raise at work will tend to consume most of the additional pay because they expect the additional pay to be in each of their future pay checks. ((Hey, what about Ricardian equivalence? In what sense aren’t all fiscal policies permanent ? Contra Taylor, “permanent” tax cuts without out spending cuts aren’t credible.))

These theoretical results depend on people having access to credit. Hypothetically, suppose you’re a poor student expecting to get a lavishly paid job when you go on the job market next year because you expect no Economic department budgets will be cut in the aftermath of the Great Depression 2.0. Let’s say. Anyway, you know you’re income will be much higher in the future and you’d like to spend some of that higher income today. There’s no reason for your future self to live high on the hog while your stuck in the present eating Top Raman. In other words, you’d like to borrow from your future self. Well, that’s not very likely because access to credit for poor students is limited.

Now, suppose the government sends you a check for $500. Even though this is a temporary increase in your income, contrary to that fancy economic theory above, you’re going to consume it all and not save any of it. You do this because you wanted to borrow money from you future self, but weren’t able to. You not saving is, in effect, you borrowing from your future self.

But darn us economist, here we are talking about efficiency again. What if government actors care about maximizing the consumption of the least well off? Sure their stated preferences, as evidenced by their reference to Keynsian stimulus in public statements, are for efficiency. But stated preferences and a smile buys you crappy happiness research. Instead the government may just care about those most hurt by recession and those most likely to be credit constrained and thus those more likely to increase their consumption after fiscal stimulus.

Does our Benovolent Dictator (with a mouse in his shirt pocket to make my title work) have maximin preferences? If his preferences reflect a typical individuals social preferences or the median voter’s typical social preferences, then my guess is yes.

8 thoughts on “Of mice and maximin”

  1. But poor students have access to credit. Actually, I’m having a hard time coming up with a very clean example for credit constraints. Maybe we could come up with some sort of credit rationing because of informational issues instead.

    Also, see Michael G.’s comment on my post.

  2. Maybe. In expectations, accounting for people who fail to realize the potential of their college-acquired human capital (for various reasons), it’s not obvious that college students are not pulling back enough of their lifetime income.

  3. If you don’t like the college student example, then take a look at the payday loans market. Its been a while since I saw an seminar on this, but the interest rates there imply outrageously huge discounts assuming complete markets.

  4. But people with bad credit histories (bad credit types, if you’d like) ought to be constrained in terms of what rates they’d need to pay. (Uh, my wording is off today…)

    If you think that payday loan clients are rationed then by all means, go make a profit by offering them terms closer to the “fair bet”. I wouldn’t.

  5. Ok. Another example, car loans for low income folks:

    We investigate the significance of borrowing constraints in the market for consumer loans. Using data from the Consumer Expenditure Survey on auto loan contracts we estimate the elasticities of loan demand with respect to interest rate and maturity. We find that, with the exception of high income households, consumers are very responsive to maturity and less responsive to interest rate changes. Both elasticities vary with household income, with the maturity elasticity decreasing and the interest rate elasticity increasing with income. We argue that these results are consistent with the presence of binding credit constraints in the auto loan market.

  6. OK, I agree. There’s definetively some of it going on. My point was that it’s a lot less than it used to be or than we’re used to think there is.

    But thanks for finding a reference!

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