Wednesday, May 15, 2013

MPC discredited?

Steve Roth ponders the Marginal Propensity to Consume (MPC) here:

...since those workers have a high propensity to spend their income, all things being equal that distributional shift should mean there’s ... a virtuous cycle.

and again here:

Sumner, Drum, and Krugman all seem to think that the distribution/MPC/velocity argument has no legs. They’re quite categorical about this.

It is a big deal, because a lot of things fall into place if the MPC idea holds good. If it doesn't hold good, people should be a little more explicit about how it fails than Paul Krugman is:

...that the rich spend too little of their income. This hypothesis has a long history — but it also has well-known theoretical and empirical problems.

If it doesn't hold good, people should be a little more explicit about how it fails than Scott Sumner is (at the first link):

you really need to give up on that MPC stuff, it was discredited decades ago.

The quest for a better explanation of what's wrong with the MPC idea is Roth's focus in comments at the first link (in response to Sumner)...

I’ve poked around a lot looking for a straightforward, cogent refutation (that doesn’t make assumptions that I consider to be questionable). Any leads for me?

... and at the second link, in its entirety. Roth writes:

Can folks (especially those who don’t believe this argument) point me to what might be considered definitive takedowns? I have notions about what they might say, but want to see the best argument(s) out there.

I want to see too, Steve. But I suspect they're a lot like the arguments for free trade:
1. "It's obvious"
2. "We'll get to that later" (and later, they only say "It's obvious"), or
3. something incomprehensible, just to shut us up.

Roth is looking for "the slam-dunk argument that has Krugman and especially Drum convinced that the MPC argument doesn’t hold water".

You know what I like? I like it that even though the MPC explains a lot in a most satisfactory way, Roth is willing to accept that the idea is garbage -- *IF* someone can make the convincing argument. That's the right way to do economics: "always approaching" the best answer.

Anyway, I decided to look through some textbooks for views on the Marginal Propensity to Consume. Maybe that would be the easy way to find the concept discredited, I thought. I went first to McConnell's 1975 edition of Economics:
The proportion, or fraction, of any change in income which is consumed is called the marginal propensity to consume (MPC). Or, alternatively stated, the MPC is the ratio of a change in consumption to the change in income which brought the consumption change about; that is:

This is a bit different from Steve Roth's (admittedly brief) "poorer people spend a larger share of their income/wealth than richer people." And maybe that opens up a door. Because even of the marginal propensity to consume *is* junk, Roth's non-marginal observation may still be true.

In his 1975 textbook McConnell wrote:
Economists are not in complete agreement as to the exact behavior of the MPC and MPS as income increases. For many years it was presumed it was presumed that the MPC declined and the MPS increased. That is, it was felt that a smaller and smaller fraction of increases in income would be consumed and a larger and larger fraction of these increases would be saved. Many economists now feel that the MPC and MPS for the economy as a whole are relatively constant. Statistical data such as those of Figure 11•2 are consistent with this position.

These "feelings" that McConnell describes -- is that all there is?

McConnell's Figure 11•2:

Source: Economics by Campbell R. McConnell (Sixth Edition) Page 229

Reiterating the notes below the figure, a dot would be on the 45-degree line (the black line) if every dollar of disposable income were spent. Where a dot falls below the black line it indicates that some part of disposable income has been saved. The farther the dot falls from the black line, the greater the amount that was saved.

McConnell says the brown line "suggests that households spend a larger portion of a small income than they do of a large income." I agree: The brown line is not a trend-line for the dots. The brown line is a "constant percentage of income" line. For the years since 1946 through 1966 the dots are generally above the brown line. For the years after 1966 the dots are generally below the brown line. At the higher incomes, saving was generally greater than at the lower incomes.

But somehow, that doesn't feel like a slam-dunk argument.

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