previous CHAPTER 8

Chapters 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Chapter 1
General Economic Concepts
Chapter 2
What is Policy?
Chapter 3
History of Macroeconomic Policies in the United States
Chapter 4
Policy Goals: Maximum Employment
Chapter 5
Policy Goals: Maximum Production
Chapter 6
Policy Goals: Price Stability
Chapter 7
Policy Goals: External Balance
Chapter 8
Subsidiary Policy Goals
Chapter 9
Conflicting Policy Goals
Chapter 10
The Policy Makers
Chapter 11
The Policy Instruments
Chapter 12
The Decision-Making Processes
Chapter 13
The Policy Indicators
Chapter 14
The General Economic Model
Chapter 15
Monetarist Monetary and Fiscal Policies
Chapter 16
Keynesian Monetary and Fiscal Policies
Chapter 17
Debt Management Policies
Chapter 18
Incomes Policies
Chapter 19
Supply Management Policies
Chapter 20
The Long Wave
Chapter 21
Contemporary Issues
  1. National Savings Rate
  2. Indebtedness
  3. Income Distribution
  4. Poverty
  5. Quality of Life
  6. Stable Financial Markets
  7. Summary
top    I. National Savings Rate
"If you would be wealthy, think of saving as well as getting."

Benjamin Franklin
American Author, Diplomat, Inventor, Physicist, Politician, and Printer
The Way to Wealth (1758)

The national saving rate is the total amount of saving as a percentage of total income, s = S/Y. The gross saving rate includes saving from all three domestic sectors — households, businesses, and governments. To sustain economic growth in the long run, the saving rate must be sufficient to cover the investment rate:

s > d, where s = S/Y and d = I/Y

Capital accumulation depends upon how much society is willing and able to set aside and forego in the way of current consumption to make funds available for investment.

The net saving rate is the gross saving rate less capital consumption allowance (the amount of capital used up during the year). Saving from capital consumption allowance is available to replace the existing capital stock. Net saving is what is available to buy new capital and increase the capital stock. Therefore, the net saving rate is the most important measure of saving for economic expansion.

The chart to the right shows that the net saving rate in the U.S. has been negatve throughout the 2000s. The difference must be financed by foreigners. The chart below shows that net saving from foreigners (net borrowing from foreigners) has been postive throughout the 2000s.

The household sector has been the principal source of net saving for the U.S. economy. In the post–World War II period, households provided, on average, 77% of net saving. Coming out of the War, the personal saving rate was 7% and it grew to over 10% in the 1970s, but fell back to 7% by the late 1980s and then dropped precipitously to under 2% in the 2000s. The personal saving rate is calculated as the ratio of personal saving to disposable personal income.



Personal Saving Rate

Corporate Saving Rate

Corporate Saving Rate (less Capital Consumption Allowance)

Total Private Saving Rate

Net Government Saving Rate

Total Saving Rate

Total Investment Rate

Net Domestic Saving Rate

Net Investment Rate

Net Inflow of Foreign Saving

1950s 5.5% 10.7% 0.4% 16.2% 4.5% 20.7% 15.7% 10.4% 5.4% –5.0%
1960s 5.7% 11.3% 1.4% 17.0% 3.9% 20.9% 15.4% 11.0% 5.5% –5.5%
1970s 6.7% 11.5% –0.7% 18.2% 1.2% 19.4% 16.6% 8.6% 5.8% –2.8%
1980s 6.6% 12.4% 0.3% 19.0% –0.8% 18.2% 16.8% 6.1% 4.7% –1.4%
1990s 3.8% 12.2% 0.4% 16.0% 0.3% 16.3% 15.4% 4.5% 3.6% –0.9%
2000s 1.2% 13.0% –0.7% 14.2% 0.5% 14.7% 16.1% 2.4% 3.8% 1.4%
Source: Bureau of Economic Analysis and FRED.

A high personal saving rate was considered necessary to net saving because the federal government has run mostly budget deficits since 1969. from 1997 to 2000, net saving was subsidized by federal budget surpluses. Yet, even with the federal — and state and local government — budget surpluses, gross domestic saving was just sufficient to finance gross domestic investment. Since 2000, the federal government budget surpluses have given way to huge deficits and investment has been financed by a net inflow of foreign saving. If the U.S. economy is to expand, its personal saving rate must increase.

top    II. Indebtedness

"Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery."

Wilkins Micawber
The Micawber Principle
David Copperfield, by Charles Dickens (1850)

The flip side of the low saving rate is the high rate of indebtedness. All sectors of the economy are at fault — saving less and financing more — to live beyond current means. As of the end of 2009, households, non–financial businesses, and all governments had accumulated total debt of $34,654.8 billion. These liabilities exceeded current GDP for 2009 ($14,453.8 billion) by 240%.












State & Local


Domestic financial services


1950 $467.2* $74.1 $45.0 $29.1 $142.2 $123.6 $—— $250.9** $—— $——
1960 $724.1 $211.7 $133.8 $61.2 $204.3 $148.6 $72.2 $236.0 $—— $23.2
1970 $1,421.7 $453.4 $273.6 $133.8 $518.5 $358.7 $219.4 $299.5 $—— $52.1
1980 $3,953.5 $1,396.0 $926.5 $358.0 $1,478.1 $910.2 $344.4 $735.0 $578.1 $193.4
1990 $10,834.7 $3,595.9 $2,503.7 $824.4 $3,753.3 $2,535.8 $987.4 $2,498.1 $2,613.6 $318.2
2000 $18,080.8 $7,008.3 $4,810.5 $1,748.6 $6,489.7 $4,530.8 $1,197.7 $3,385.1 $8,157.8 $814.5
2009 $34,654.8 $13,602.1 $10,334.4 $2,478.9 $10,892.5 $7,113.2 $2,354.7 $7,805.4 $15,609.7 $2,064.0
* Excludes foreign debt
** Combined state, local, and federal debt
Source: Federal Reserve, Flow of Funds Accounts

Federal Government Debt

The federal government is the single largest debtor. The federal government debt (the public debt or the national debt) was $12,311.3 billion as of the end of 2009. The public debt (to the penny) increased from about $25 billion after WW I to $50 billion in 1940, before WW II, to $269.4 billion in 1946, just after WW II, to just under $1 trillion during the 1980 Presidential campaign. As a percentage of GDP, the debt ratio rose to 124.4% in 1946. Following WW II, the debt declined absolutely and in relative terms. By 1951, the debt began to increase in absolute terms, but it continued to decrease as a percentage of GDP. By the mid–1970s, the debt was only 33% of GDP and that rate continued to decline to 26.1% in 1980.

In 1980, Ronald Reagan campaigned for office on a platform that criticized former President Carter for a public debt that was approaching $1.0 trillion dollars. When Reagan took office as President in January 1981, the public debt was $930.2 billion. When he left office eight years later, the public debt had increased by more than 288% to $2,684 billion.

Since 1980, the debt has increased by more than 1,300%. Heavy borrowing to finance federal budget deficits in the 1980s and 1990s pushed the debt to a peak of $5,776 billion at the end of 1999. As a share of GDP, the public debt increased from 26.1% in 1980 to almost 65% in 1999. With federal budget surpluses in fiscal years 1998, 1999, and 2000, the federal government began to pay down some of its debt. When former President Bush took office in January 2001, the public debt was $5,662 billion. During Bush's presidency, however, the public debt increased by 100% to $10.7 trillion or about 70% of GDP, thanks to an economic downturn and Congressional passage of the Troubled Assets Relief Program (TARP) in Fall 2008. When Obama took over from Bush, the public debt was $10.7 trillion, but thanks to a further decline in the economy and Congressional passage of the American Recovery and Reinvestment Act of 2009 (ARRA), the public debt was $12.3 trillion at the end of 2009. Check to see what the public debt is today.

Even with surpluses, the public debt will continue to grow. The debt will grow, because reported surpluses do not include monies borrowed from trust funds. Even if surpluses resume, the trust fund deficits are also expected to increase. The trust funds holding the largest amount of public debt securities are the civil service and military retirement fund, the social security trust fund, and the medicare trust fund.

The gross federal debt is the first most critical element, because it is the debt on which the federal government is paying interest. Interest is a legal obligation and must be paid regardless of tax collections. In 1980, the government paid $52.5 billion in interest on the debt. Interest expense peaked at $244.0 billion in 1996 and has since decreased to $153.1 billion in 2002. However, it subsequently increased to $404 billion for 2006. In 1980, the debt service was 1.9% of GDP. That ratio rose to 3.3% in 1991, decreased to 1.4% in 2003, but has risen again to 3.0%. As of December 31, 2006, the average interest rate that the federal government is paying on its marketable debt is 4.9%. That rate is down from 6.6% that the federal government paid at the beginning of 2001.

The marketable debt is the second most critical element, because this portion of the debt is owed to persons and institutions outside the government, government agencies, and government trust funds and it must be repaid when it matures. If the government does not have the money to repay, it must refinance or rollover the old debt. For refinancing, the government is totally dependent upon the state of the financial markets and the psychology of lenders. If interest rates have gone down, the government saves in interest expense, but may find few lenders willing to buy the new debt. If interest rates have increased, the government will probably find willing lenders, but its interest expense will also increase. As of the end of 2009, the par value of the marketable debt was $7,805.4 billion or more than 50% of the gross debt.

The foreign debt is the third most critical element, because foreign lenders are increasing in number and they are the least loyal to the U.S. markets. Foreigners are most likely to sell their U.S. debt when relative interest rates change or adverse events occur in the U.S. When they lend, they help to decrease U.S. interest rates. However, when they sell, U.S. interest rates increase. Foreign holdings of U.S. public debt rose from $129.7 billion in 1980 to $2,064.0 billion or approximately 26% of marketable debt as of the end of 2009. Foreign holdings had been higher in the mid-2000s, when they reached almost 50% of marketable debt. China and Japan are the largest single holders of US. public debt.

The growth of the debt is the final most critical element, because its trend is to increase continually. In theory, the public debt is limited by congressional legislation. In reality, Congress sets a debt ceiling, but then it raises the ceiling, as the need arises, to accommodate new deficits. Since Congress is also responsible for passage of the annual budget, Congress can continue to spend more than it receives, as long as it raises the debt ceiling each year to accommodate financing of the annual deficit. In March 2007, when the total public debt subject to limit reached $8,760.7 billion, Congress voted to increase the debt ceiling to $8,965 billion. Congress subsequently voted to raise the debt ceiling to $12,394 billion to accommodate expenditures under TARP and, then, in February 2010, Congress voted to raise the debt ceiling to its current level of $14,294 billion to allow for expenditures under ARRA.

Consumer Debt

Consumer debt is probably the most troublesome. It is the single largest component of domestic indebtedness. Consumer debt was not always the single largest component of domestic indebtedness. Prior to 1991, business debt was larger than consumer debt. During the recession in 1991, business debt declined as consumer debt continued to increase. Since 1990, consumer debt has increased by 278% from $3,595.9 billion to $13,602.1 billion while business debt has increased by only 190% from $3,753.3 billion to $10,892.5 billion.

This role reversal between consumer and business debt is a two–edged sword. Consumer purchases perennially account for over two–thirds of all spending. A strong consumer goods sector is good because it pulls along production in the capital goods sector. However, when consumer goods are financed, the financing draws monies away from businesses. Businesses must pay higher interest rates to finance production and they pass these cost increases along as higher prices to consumers. Moreover, consumer–financed spending sprees must eventually grind to a halt as consumers stop to pay off past purchases. At that point, businesses are left with unwanted inventories that they need to liquidate to pay off their high–cost borrowing.

Consumer–financed spending will continue as long as consumers feel confident about the future. However, consumers may stop spending, if their mood turns pessimistic. If the economy goes into a recession, unemployed households will be the least likely to repay their borrowings. Something similar happened in 2008-2010. Consumer spending peaked at $10,220.1 billion in the third quarter of 2008, but, then, as unemployment rose sharply from 5.0% in April 2008 to 9.5% in June 2009, consumer spending dropped to $9,987.7 billion through the second quarter of 2009, before increasing again in 2010 to surpass 2008 spending levels. The drop in spending was direct correlated with job losses and loss of confidence in the economy.

Consumer debt includes both mortgage debt and installment debt. Mortgage debt is used to buy or to refinance real property and includes first mortgages, second mortgages, and home equity loans and secured lines of credit. Consumer debt is used to buy personal property and includes revolving credit (credit card debt and unsecured lines of credit) debt and installment debt (consumer loan debt).

As of December 31, 2006, consumers owed $12,817.2 billion or 96% of GDP. Mortgage indebtedness increased by 489% from $1,647.0 billion in 1986 to $9,704.7 billion in 2006 or 72% of GDP. Changes in the tax laws in 1986 eliminated the deductibility of interest on credit card debt and consumer installment loans and made only interest on mortgage indebtedness deductible after January 1, 1987. Since 1986, home equity loans and lines of credit have been the fastest growing source of finance for most families. Thus, even a small decrease in property values could mean rising defaults on home equity loans.

Mortgage indebtedness did drop from $12,817.2 billion in 2006 to $10,334.4 billion in 2009 as a result of the subprime mortgage crisis. The default rate on subprime mortgages rose sharply as rates on many of these loans were resetting in 2007 and borrowers could not afford the higher monthly payments. Foreclosures forced house sales and increased house sales forced housing prices to decline. Some mortgagors walked away from mortgages where their houses were "under water" (house price less than mortgage balance). Other mortgage default rates rose where indivdiuals were laid off or dismissed from employment and they could not afford to maintain their mortgage payments.

Consumer loan indebtedness has also increased steadily despite the loss of its interest rate deductibility. It increased by 272% from $666.4 billion in 1986 to $2,478.9 billion in 2009 or 17% of GDP. At the end of 2009, revolving credit was $866.0 billion and non–revolving credit was $1,582.8 billion. Whether or not this burden is onerous depends on one's perspective of the problem.

First of all, fear of the rising debt emphasizes its antithesis — the low saving rate — as a negative for future growth. Second, consumer debt as a percentage of disposable personal income (DPI) has increased from less than 16% in 1980 to over 19% in 2006. This 19% was the highest debt–to–DPI ratio in history. Fortunately, the percentage dropped back to a more manageable 17% in 2009. However, the decline was a result of a downturn in the eocnomy. Third, debt service — the percentage on disposable personal income that consumers pay in interest on their borrowing — has risen from approximately 11% in the early 1980s to over 14% as of 2006. This 14% is the highest debt service ratio in history. Fourth, not all individuals are affected equally. About one–half of all credit card debt is repaid in total each month. However, the other one–half of all credit card debt is paid off at the minimum amount each month. The debt–to–DPI ratio of those least able to pay is much higher than it is for those who can afford to pay. Thus, even a small recession in the economy could mean rising defaults on consumer installment and credit card loans.

On the brighter side, consumer debt has become less onerous. Payback periods have lengthened, thus reducing the current monthly payment burden. About half of all credit card debt is repaid each month. The fastest growing segments of the population, who rely most heavily on credit, are those in their 20s, 30s, and early 40s. Most of the "baby boom" generation is now in their 50s and 60s. As this generation gets older, the debt–to–DPI ratio should decline. However, a recent study showed that senior citizens, those 65 years of age and older, have the fastest rising indebtedness rate. Many of these people live on fixed incomes and cannot afford to become overly indebted.

ASSETS BY SECTOR (in billions)
















1950 $1,808.9 $1,114.9 $243.3 $736.0 $640.1 $517.8 $122.3 $—— $—— $53.9 $——
1960 $3,122.3 $2,007.9 $486.9 $1,349.0 $1,045.6 $837.9 $207.7 $—— $—— $68.8 $——
1970 $5,891.7 $3,732.7 $874.5 $2,528.1 $2,021.4 $1,605.8 $415.6 $—— $—— $137.6 $——
1980 $17,856.5 $10,408.3 $2,943.2 $6,554.9 $6,988.2 $5,400.5 $1,587.7 $—— $—— $460.0 $——
1990 $37,501.9 $23,064.6 $6,585.0 $14,580.5 $13,395.3 $9,463.6 $3,931.7 $—— $—— $1,042.0 $——
2000 $74,675.5 $47,424.9 $11,407.9 $33,002.1 $25,393.6 $14,248.2 $11,145.4 $—— $—— $1,857.0 $——
2006 $103,987.3 $66,589.1 $20,606.9 $42,058.8 $34,996.5 $20,576.3 $14,420.2 $—— $—— $2,401.7 $——
* Excludes government real assets and foreign assets
** Includes financial assets of nonprofit organizations
Source: Federal Reserve, Flow of Funds Accounts

In addition, consumers are wealthier than ever (or at least they were prior to 2008). Given the surge in home prices during the 1980s, the rise in stock prices during the 1990s, and another surge in home prices during the 2003–06 period, household assets increased by 540% from $10,408.3 billion in 1980 to $66,589.1 billion at the end of 2006. Consumer net worth rose by 497% from $9,012.3 billion in 1980 to $53,771.9 billion at the end of 2006. Thus, consumers can afford to take on more debt. However, a major trouble spot is the decline in the ratio of assets to liabilities. In 1980 assets covered liabilities by almost 750%. As of 2006 that coverage is only 520%.

NET WORTH BY SECTOR (in billions)










State &



1950 $1,538.5 $1,040.8 $497.7 $317.2 $180.5 $—— $—— $—— $——
1960 $2,565.1 $1,796.2 $768.9 $528.5 $240.4 $—— $—— $—— $——
1970 $4,643.9 $3,279.3 $1,364.6 $943.8 $420.8 $—— $—— $—— $——
1980 $13,483.3 $9,012.3 $4,471.0 $3,093.7 $1,377.3 $—— $—— $—— $——
1990 $26,785.6 $19,468.7 $7,316.9 $4,953.8 $2,363.1 $—— $—— $—— $——
2000 $53,575.2 $40,416.6 $13,158.6 $9,404.6 $3,754.0 $—— $—— $—— $——
2006 $73,674.3 $53,771.9 $19,902.4 $14,048.5 $5,853.9 $—— $—— $—— $——
* Net worth of households and businesses (excludes government and foreign net worth)
** Includes financial assets of nonprofit organizations
Source: Federal Reserve, Flow of Funds Accounts

Business Debt

Business debt was the single largest component of domestic indebtedness prior to 1991, but has lagged behind consumer debt since that time. Business debt is generally considered to be "good" debt, because the money raised from such borrowing goes to buy capital which expands the resource base. As long as the debt is for acquisition of new capacity–increasing capital, the debt can be justified. However, throughout the 1970s, much corporate debt went to finance capital to satisfy EPA and OSHA requirements, and, during the 1980s, much of the new corporate debt was used to finance takeover activity — the purchase of existing assets, not the creation of new assets. The frenetic pace of restructuring and leveraged buyout deals (LBOs) of the mid–1980s increased the financial obligations of many corporations without increasing their capacity for producing more output.

During the 1990s, corporate debt was used to finance capital with new technologies in the telecommunications and information processing areas. Such capital did not increase capacity, per se, (capital widening). However, it did increase the efficiency of existing capital (capital deepening) and changed the way companies conduct business. Among other things, the new capital allowed companies to communicate and manage inventory more effectively. The use of debt to buy capital with these new technologies increased potential GDP. As a result, demand could expand without an increase in prices.

As of the end of 2009, incorporated and unincorporated businesses had borrowed $10,892.5 billion. This debt is an increase of 637% over the $1,478.1 billion outstanding in 1980. Corporate debt has grown faster than the debt of unincorporated businesses. In 2009, about 65% of business debt or $7,113.2 billion was held by corporations and 35% or $3,779.3 billion was held by unincorporated businesses. The $10,892.5 billion in debt supports $—-- billion in assets. However, business acquisition of financial assets has been growing faster than its acquisition of real assets. From 1980 to 2006, financial assets increased by 808% from $1,587.7 billion to $14,420.2 billion while real assets increased by only 281% from $5,400.5 billion to $20,576.3 billion. Real assets are used to produce goods and services. Financial assets are not. If this trend continues, American businesses will not produce much in the way of goods and services. It will just shuffle financial assets.

Net Foreign Debt

Net Foreign Debt Following repayment of the Revolutionary War debt, American borrowing from foreigners was almost negligible. From the end of World War I through 1984, foreigners borrowed more from the United States than the U.S. borrowed from abroad. However, the high dollar and slow productivity gains of the early 1980s gave the U.S. less of a cost advantage in selling abroad, while foreigners glutted the U.S. market with lower priced imports. In 1984, the U.S. crossed the line and became a net debtor to the rest of the world for the first time since World War I. By the end of September 2000, federal debt held by foreigners had climbed to $1,225.2 billion.

At the end of 2006, foreign holdings of the public debt almost doubled to $2,223 billion. Foreign holdings were 44% of the total public debt held by the public. Foreign central banks owned 64% of the public debt held by foreigners. Private individuals owned nearly all the rest. The People's Republic of China holds the most U.S. debt, ending the first quarter of 2007 with over $1.2 trillion in total foreign reserves, of which about $420.2 billion are U.S. Treasury securities. The country holding the second most U.S. debt is Japan which held $612.3 billion at the end of the first quarter of 2007.

top    III. Income Distribution
"If all the rich people in the world divided up their money among themselves there wouldn't be enough to go around."

Christina Stead
Australian Novelist and Short Story Author
House of All Nations (1938) "Credo"

Measuring Income Distribution

Income distribution is the dispersion of income among different classes of people and households. The degree of inequality is measured, first, by constructing a Lorenze curve. Then, the Gini coefficient is calculated from the Lorenze curve by taking the area between the Lorenze curve and the diagonal as a fraction of the underlying triangle. A zero (0) means perfect equality. As the coefficient rises toward one (1), incomes become more unequal.

The distribution of income in the United States has changed dramatically over the last forty years. Inequality among income groups has increased. The Gini coefficient for the United States has risen consistently and significantly from 0.399 in 1967 to 0.0.467 in 2007. See Census Bureau, p 16. However, when means–tested government cash transfers are included, the Gini coefficient has remained relatively constant at 0.40. Other countries that have a Gini coefficient of 0.39-0.41 are Burkina Faso, Georgia, Ghana, Israel, Macedonia, Malawi, Mali, Mauritania, Morocco, Russia, Sri Lanka, Turkmenistan, and Tunisia. See List of Countries by Income Equality.

Experimental Measures of Income and Poverty

Causes of Income Inequality

Income inequality is often the result of differences in the quantity of factor resource endowments. Most people have labor that they can supply to earn wages. Some people have saving that they can supply to earn interest. A few people own land from which they earn rent. A special group of people are entrepreneurs, who own capital, and earn profit. Wage income has risen from about 67% of total income in the mid-1950s to about 75% in the mid-1980s to ??% in the mid-2000s. Interest income has risen from less than 2% of total income in the mid-1950s to more than 10% in the mid-1980s to ??% in the mid-2000s. Rental income has fallen from nearly 4% of total income in the mid-1950s to less than 1% in the mid-1980s to ??% in the mid-2000s. Corporate profits have shrunk from about 14% of total income in the mid-1950s to about 8% in the mid-1980s to ??% in the mid-2000s.

  Mid–1950s Mid–1980s Mid–2000s
Wages 67% 75%
Interest 2% 10%
Rent 4% 1%
Profits 14% 8%
Self-employment income 13% 6%
Source: Alfred L. Malabre. "Solid Growth: Despite Big Problems, U.S. Economy Seems Surprisingly Health," Wall Street Journal. 2 Jun 1986: 10.
The struggle by different groups to expand their respective income shares is not new. Writing in the mid–19th century, Marx envisioned a revolutionary struggle between workers and capitalists (owners) that would end in a communist state. Marx believed that the capitalists would appropriate the profits from business for their own gain at the expense of the workers and that the workers would be exploited and ultimately subject to living on subsistence wages.

In the post–World War II period, just the opposite has occurred and wage income has increased at the expense of a declining rate of profit. While this is good for workers in the short–run, declining rates of profit depress the entrepreneurial initiative to expand output. Thus, one finds, over longer periods of time, alternating shifts in the distribution of income as each group attempts to catch the other.

When a severe imbalance occurs, the government may step in to redress the problem by redistributing income. If the rate of profit falls too low, investment and growth slow; therefore, policies designed to shore up profits may be in order. In other instances, where workers wage income falls behind such that the standard of living falls, policies designed to increase labor's share may be executed.

Income can be redistributed through a progressive tax structure, by shifting the tax burden from personal to business income taxes and back again, or by subsidizing the affected low–income group. Alternatively, the government can use wage and price controls to adjust income shares and tax incentives to adhere compliance to a redistribution scheme.

Income inequality results from differences in the quality of labor resources. Some people have more brain or brawn than others. Some have invested time and money in education and training to develop special skills that earn high salaries. In general, the greater the education, the higher the income. To reduce inequality by improving factor quality, the government must use supply–management policies to provide education and man–power training programs.

Finally, income inequality is often the result of discrimination. Blacks and hispanics tend to have the lowest incomes, while white non–hispanics and Asians tend to have the highest incomes. Females tend to earn much less than males. Redressing discrimination problems generally involves changing laws and the social conscience.

top    IV. Poverty

"Wealth is the parent of luxury and indolence, and poverty of meanness and viciousness, and both of discontent."

Greek Author and Philosopher
The Republic (c. 360-380 BC)

Poverty is the problem of low income, regardless of source. Poverty is a very broad term. Before government officials can deal with poverty, they first have to define what is meant by poverty and a poverty level of living. Very arbitrarily, an income figure is established as the poverty line for a family of four living in the city. All other poverty levels are adjusted by number of members in the family and geographic location.

Amid the rising affluence since World War II, poverty has diminished. In the late 1950s, 15.2% of white families and 48.1% of black ones were living below the federally determined poverty line. By the mid–1970s, these percentages had dropped to 6.8% for whites and 27.0% for blacks. By the mid-1980s, however, the figures had edged back up to 9.1% for whites and 30.9% for blacks.

AND POVERTY ($ 1985)
Position in Income Distribution Average Annual Income in 1973 Average Annual Income in 1985 Percentage Change
Top fifth $65,509 $65,702 +0.3%
Fourth fifth $40,177 $38,399 –4.4%
Middle fifth $30,020 $27,724 –7.6%
Lowest fifth $ 9,639 $ 6,529 –32.2%
All families with children $33,352 $31,167 –6.6%
Percentage poor* 11.4% 16.7% 46.5%
*Percentage of all persons in families with children who have incomes below the official poverty line.
Source: Danziger, Sheldon and Peter Gottschalk. "Target Support at Children and Families," New York Times. 22 Mar 1987: 3(2).
The period since the early 1970s has been one of economic stagnation and increasing poverty and inequality, especially for single–parent households and families with children. For the first two post–WW II decades, mean income for families with children, adjusted for inflation, grew at an annual rate of 6% per annum. Poverty declined rapidly and inequality lessened somewhat. From 1967 to 1973, annual growth rates were about 3% for two–parent families and less than 1% for female–headed families. Since 1973, growth has actually been negative, while poverty has increased substantially. In 1973, the income of the top fifth was about seven (7) times that of the lowest fifth; but, by 1985, it was ten (10) times as large. The paradox of continuing high poverty during a prolonged recovery can be seen in the table to the right.

Throughout the 1973–85 period, the working poor, in particular, were adversely affected by all three of the main mechanisms through which income is generated and distributed. First, increased unemployment rates and declining real wages pushed many working poor below the poverty line. Second, while they could have been helped by increased support from government income maintenance programs, the benefits of such programs were eroded by the high inflation of the late 1970s. Finally, during the Reagan administration, most programs aiding the non–elderly poor were cut. Deteriorating market incomes and reduced government benefits led to a sharp decline in pretax incomes; yet taxes on incomes of the poor rose steadily from the mid–1970s through 1986. In 1975, a family of four with earnings at the poverty line paid 1.3% of its income in personal taxes. By 1985, this proportion had risen to 10.5% enough to wipe out all and more of the benefits from food stamps.

If simply alleviating poverty is one of the goals, then some negative income tax or transfer payment system is sufficient. With a negative income tax or transfer payment system, those above the poverty line are assessed a positive tax; those below the poverty line are subsidized with those tax collections. Alternatively, not all people are poor for the same reasons. Poverty is more the symptom of a disease rather than the cause, and if the patient is to live, government officials ultimately have to treat the cause, not just the symptom. They have to look at why individuals and families fall below the poverty line.

Some people are poor because they are unemployed. They may have been thrown out of productive occupations because of changing demands or technology. They may lack the necessary education or training and skills to find a job. A good percentage of the poor are farmers, whose incomes depend upon the vagaries of the market, climatic conditions, and international public policies. Divorce is to blame in some cases. Increasingly, those families below the poverty line are headed by single parents, most notably by females, whose unemployment rate has been typically higher than that of their male counterparts. Many of these women cannot work because they have small children at home and no one to care for them.

Since not all people are poor for the same reasons, programs to relieve poverty must be tailored to the specific cause. For those who are temporarily unemployed, unemployment compensation. For those whose jobs have been displaced, job training programs. For farmers, income subsidies. For women with young children, day care center facilities. Other programs such as "workfare" and refundable tax credits have also been suggested.

top    V. Quality of Life
"It is pretty hard to tell what brings happiness; poverty and wealth have both failed."

Frank McKinney "Kin" Hubbard
American Cartoonist, Humorist, and Journalist

Generally, the level of living is a term used to describe the material (quantitative) standard of living. The term, standard of living, includes both quantitative and qualitative assessments. This section examines quality-of-life factors as opposed to mere material factors.

Anxious Index

Feeling sad? Feeling blue? Can't sleep at nights? Worried about the future? Your job? Maybe those fears are valid; maybe they are not. Fear and anxiety about future economic conditions, especially those that would affect individuals diretcly (whether or not realized), reduce the quality of life. Check out the Anxious Index. The Anxious Index is an index that measures the probability of a decline in real GDP, as reported in the Survey of Professional Forecasters. A forecast for a decline in real GDP is signal for layoffs and increased unemployment.


Misery Index

Year Unemployment Rate Annual Average Inflation Rate Annual Average* Annual Misery Index
1970 5.0 5.9 10.9
1971 5.9 4.2 10.1
1972 5.6 3.3 8.9
1973 4.9 6.3 11.2
1974 5.6 11.0 16.6
1975 8.5 9.1 17.6
1976 7.7 5.8 13.5
1977 7.0 6.5 13.5
1978 6.1 7.6 13.7
1979 5.8 11.3 17.1
1980 7.2 13.5 20.7
1981 7.6 10.4 18.0
1982 9.7 6.2 15.9
1983 9.6 3.2 12.8
1984 7.5 4.4 11.9
1985 7.2 3.5 10.7
1986 7.0 1.9 8.9
1987 6.2 3.7 9.9
1988 5.5 4.1 9.6
1989 5.3 4.8 10.1
1990 5.6 5.4 11.0
1991 6.9 4.2 11.1
1992 7.5 3.0 10.5
1993 6.9 3.0 9.9
1994 6.1 2.6 8.7
1995 5.6 2.8 8.4
1996 5.4 2.9 8.3
1997 4.9 2.3 7.2
1998 4.5 1.6 6.1
1999 4.2 2.2 6.4
2000 4.0 3.4 7.4
2001 4.7 1.6 6.3
2002 5.8 2.4 8.2
2003 6.0 1.9 7.9
*The inflation rate is measured by the annual percentage change in the Consumer Price Index.
Source: Federal Reserve Bank of Dallas; Bureau of Labor Statistics.
The Misery Index is the cumulative level of living by taking into consideration the amount of income generated through employment as well as the purchasing power of money income through the rate of increase in the general level of prices. It is the sum of the inflation rate and the unemployment rate.

The index was developed by Arthur M. Okun. Mr. Okun regarded 9% as the threshold at which the country becomes "unhappy" and anything in the 20%–plus range as utterly miserable.

During the 1950s and 1960s, the index was fairly low, averaging between 5% and 7% for most of the period and rising to 10.9% in 1970. From 1970 to 1980, the index doubled, reaching an annual average of 20.7% in 1980. Since then, the index has trended downward, first, to 8.9% in 1986, and, then, after rising to 11.1% in 1991, it fell to 6.1% in 1998. Since 1999, the index has increased to about 8.0%%. Since 1993, the index has remained below Okun's critical level of 9.0%. However, it has increased significantly in the last 4 years.

Life Expectancy

Life expectancy is how long individuals can expect to live. One of the goals of improved quality of life is the extension of life itself. At the turn of the century, life expectancy for a l–year old was 55.2 years. By 1968, the rate for a 1–year old had risen to 70.7 years. By 2001, the rate had risen to 77.2 years. More Americans are living longer. At birth, white females can now expect to live to 80+ years of age.

Length of Workweek

The length of the average workweek is a measure of the work effort necessary to maintain a given standard of living. At the turn of the century, non–farm employees worked an average of 60 hours per week. Today, the non–farm employees work an average of 35 hours per week. Meanwhile, the quantity and quality of goods that the average weekly earnings can afford has more than quadrupled.

Equality of Male–Female Earnings

The equality of male–female earnings is a measure of economic equality that also has implications for social equality. It includes equality of job placement and opportunities as well as pay.

Home Ownership/Per Capita Living Space

Home ownership and per capita living space are measures of the degree of overcrowding and congestion. This problem is especially acute in metropolitan areas.

Air and Water Quality Growth is very often accompanied by negative externalities that make the environment unfit for human habitation. Sulphur dioxide emissions reduce air quality and breathing capacity and increase cancer rates. The dumping of chemical wastes into streams and rivers pollutes the water supply and causes cancers and other diseases. The greater this pollution, the lower the quality of life.

Health Care/Infant and Other Mortality Rates

The availability of health care facilities, proper nutrition, pre–natal care, and geriatric care, improve the quality of life.

Other Quality of Life Issues

Homicide rates, suicide rates, drug and alcoholic dependency rates, and instances of spousal and child abuse all have a negative impact on the quality of life.

top    VI. Stable Financial Markets

Financial Markets

Stock prices are valued by the present value of the company's earnings.

P = E(π)/r

A fall in interest rates increases the present value of expected earnings, raising stock prices and pushing down the return on interest–bearing instruments. It is presumably designed to encourage people to shift out of less risky interest–bearing securities like bonds and into more risky, speculative securities, like stocks. A rise in interest rates reduces the present value of expected earnings, pushing down stock prices and raising the return on interest–bearing instruments. It is presumably designed to encourage people to shift out of more risky, speculative securities, like stocks, and into less risky interest–bearing securities like bonds.

Financial markets tend to be more stable when the Federal Reserve targets interest rates than when it targets monetary aggregates. In targeting monetary aggregates, the monetary authority must maintain some semblance of stability and not allow interest rates to rise or fall too fast. In either case, money and capital market participants will become uncertain over the future course of interest rates and stand on the sidelines rather than participate. This inactivity slows the flow of funds from surplus income units to deficit financing units, who would have spent the funds to increase economic activity.

On December 5, 1996, in a speech before the members of the American Enterprise Institute, Alan Greenspan made reference to an "irrational exuberance" in the stock markets. He intimated that people were buying stocks, causing a run up in stock prices, which was incommensurate with the companies' abilities to generate profits at a comparable rate. By May 1997, stock prices had risen further and the members of the FOMC raised interest rates in an attempt to curb what Mr. Greenspan continued to believe was an "irrational exuberance." As the increase in stock prices mitigated in 1998, the FOMC lowered interest rates. However, by 1999, stock prices were once again on the rise. From September 1999 to August 2000, the FOMC raised interest rates six times. As a result stock prices fell throughout most of 2000. By the end of the year, NASDAQ stocks, especially new technology and dot–com companies, had lost about 40% of their 1999 year–end valuation. To avert any further decline, the FOMC lowered the target for the federal funds rate by one full percentage point in January 2001 — once between FOMC meetings.

The FOMC was especially sensitive to any instability that the World Trade Center attacks might have had on the stability of the financial markets. It flooded the markets with liquidity. At four consecutive meetings, from September to December 2001, the FOMC lowered the federal funds target rate by 1 3/4% from 3.5% to 1.75%. The FOMC continued to lower the target until it reached a fifty–year low at 1% in June 2003.

Other Goals

Other subsidiary goals, including provision for public (collective) goods, successful financing of the national debt on "reasonable" terms (low interest rates), minimizing or repaying the national debt, specific spending requests by governmental agencies, etc., may at one time or another command special attention.

top     Summary

The U.S. has four major macroeconomic goals: maximum growth, maximum employment, price stability, and equilibrium in the balance of payments. However, sometimes the state of the economy dictates that policy makers turn their attention to subsidiary goals. Some of these subsidiary goals include raising the saving rate, reducing debt, equalizing income differentials, minimizing poverty, improving the quality of life, and stabilizing financial markets. Traditional monetary and fiscal policies are not designed to deal with these subsidiary goals. To solve these problems, the government must often look to other policies, such as debt management policies, incomes policies, or supply–side policies. Narrowly defined goals tend to give rise to splinter political parties during major election years.

top    Readings

The Consumer Price Index and National Savings, Michael F. Bryan and Jagadeesh Gokhale, Economic Commentary (FRBClev), 15 Oct 1995

Inequality in the United States, Brian Motley, Economic Letter (FRBSF), 97(3) 31 Jan 1997

The 'Shrinking' Middle Class? Mary C. Daly, Economic Letter (FRBSF), 97(7) 7 Mar 1997

Charging Up a Mountain of Debt: Accounting for the Growth of Credit Card Debt, Peter S. Yoo, Review (FRBStL), 79(2) Mar/Apr 1997

Rising Wage Inequality in the U.S., Robert Valletta, Economic Letter (FRBSF), 97(25) 5 Sep 1997

Economics and Happiness, John S. Irons, (formerly The Mining Company), 14 May 1998

Income Inequality, Alan Greenspan, A Symposium, sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 28 Aug 1998

Economists Simply Shrug as Savings Rate Declines, Sylvia Nasar, New York Times, 21 Dec 1998

Public Debt: Private Asset, Government Debt and Its Role in the Economy, FRBChi, 16 Feb 1999

Rapidly Rising Corporate Debt: Are Firms Now Vulnerable to an Economic Slowdown? Carol Osler and Gijoon Hong, Current Issues in Economics and Finance, 6(7) Jun 2000

Credit Cards: Use and Consumer Attitudes, 1970–2000, Thomas A. Durkin, Federal Reserve Bulletin, Sep 2000

Household Financial Conditions, Economic Trends (FRBClev), Oct 2000

The Way We Spend Now, David Brooks, New York Times, 15 Oct 2000

Poverty in the U.S., Economic Trends (FRBClev), Nov 2000

What's Behind the Low U.S. Personal Saving Rate? Milt Marquis, Economic Letter (FRBSF), 29 Mar 2002

Are U.S. Households Living Beyond Their Means? Chris Faulkner–MacDonagh and Martin Mühleisen, Finance & Development, Mar 2004

top    Websites

Gross Private Saving, FRBStL (FRED), historical series.
Gross Saving, FRBStL (FRED), historical series.
Income, Census Bureau, current and historical series.
Poverty, Census Bureau, measurement standards; current and historical series.