(Joint post with Josh Bivens at EPI…)

There are a couple (nonexclusive) explanations worth exploring. First, it could be the case that we are seeing a once-in-a-generation shift in consumption preferences to reduce or delay consumption in favor of increased savings. As the story goes, everyone is feeling more insecure about their job, their retirement, and their future prospects; and so decide to cut back on their consumption. There is plenty of anecdotal evidence that this is the case, but in total it’s hard to determine how much this matters for the overall savings rate.

Second, it could instead  be the case that the prime driver is the inability of people to borrow (which is negative savings). Perhaps people’s desires to consume and save have not changed, but rather they have been frozen out of the credit market and thus simply unable to get a home equity loan, a car loan, or an expanded limit on their credit card. (There are other peculiarities with how total savings is measured that could be driving the change, Bill Gale notes some of these below).

There appears to be evidence that there is some of both going on.

First, we should acknowledge part of the economic shock that got us here. The wealth decline caused by housing/stock declines hits hard on two aspects of the demand side (its supply-side effects are obvious -- throwing the balance sheet of the financial sector into complete disarray) in the market for credit -- it’s both changed behavior (making people start saving) as well as robbed potential borrowers of even the chance of borrowing by robbing them of collateral - the charts here show that demand for loans fell off a ton as standards tightened  (of course, if they know they won’t qualify they could just not ask). So, there’s evidence of a credit market story over and above simple supply-side crunch.

That being said, the huge surge in savings coincided with accelerating job-losses; suggesting that the savings rate increase is stemming from consumers wanting to build a financial buffer against economic hardships.

Also, as evidence against the pure lack-of-credit story, mortgage applications and home sales have tended to track each other recently, which is suggestive that people who want to buy a house haven’t had to do much more shopping around than they ever had. (Of course, arguing against this as a useful data point is selection effects say this is surely a more credit-worthy group than what dominated the market for new mortgages in the mid-2000s.)

All-in-all, it will take time to finally determine if this is a shift or a blip. The credit crunch story is a bit oversold: while a supply-side credit crunch is certainly in play, but, it is probably leaned on too hard in lots of stories about the economy. We are more likely seeing a more lasting shift in savings rates driven by economic insecurities.

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To paraphrase Mark Twain, “Too much to drink is barely enough.”  While I’m definitely not supporting inebriation or bad behavior, it should be no surprise that as President of the American for Capital Formation my thoughts on too much saving are that it’s “barely enough.”  
 
Nobel prize winners, conservative or liberal from Friedman to Krugman, say the level of savings in an economy is a long-term indicator of its strength.  Savings, of course, consist of three components: government, business and personal.  In recent decades, the U.S. has failed on all three and this has been considered by many to be one of the triggers of the recession.
 
Of course, there is no quibble that in the midst of a recession, spending should be encouraged over increasing the national savings rate, but increased savings will be beneficial in the long-term in promoting economic health and hopefully help prevent the next economic tsunami.
 
Nevertheless, I believe that the current rise in savings is a short-term phenomenon triggered by the downturn. Middle America is reacting to fears that they will lose their job, their health care, the hope of their kid going to college and insecure retirement.  But I don’t think it’s a long-term shift in consumer sentiment, because despite what Benjamin Franklin taught us a long time ago that  "a penny saved is a penny earned,” buying a Starbucks coffee on a credit card is now almost as American as apple pie.

I’m not sure what long-term impact the recession will have on savings patterns, although its true that the children of the depression were tempered by it, were fearful about going into debt and were astonished that their grandchildren were spending like drunken sailors.
 
If we truly want to see greater long-term saving across the personal, business and government components there is one policy lever we should look at. In a serious debate on fundamental tax reform, we should not be confined to the contours of the income tax (as most of the initiatives from Congress do) and as seems to be the direction of President Obama's tax reform initiative.  Rather, we should give consideration to a shift from an income tax to a consumption tax.

Numerous academic studies have shown that if the U.S. had a consumption tax instead of our U.S. income tax, there would be greater economic growth resulting from increased investment made possible by higher saving levels (government, business and personal).  Mr. and Mrs. Middle Class would also feel more secure if their savings were not penalized as they plan for their kid's education, set aside savings for emergencies and prepare for their golden years.

It’s time for long-term economic health of America to treat saving as a virtue rather than as a sin!  

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The personal saving rate has soared in recent months. According to the national income and product accounts, personal saving in 2007, the last year before the start of the recession, was $57 billion. In the January-March 2009 calendar quarter, the annual rate of personal saving was $464 billion, an eight-fold increase. In May 2009, the rate of personal saving rose still further, reaching an annual rate of $769 billion, nearly fourteen times the saving rate in 2007. 

It may seem puzzling that personal saving would soar at a time of surging unemployment and falling wages and business profits. Private consumers are worried, however, that their private incomes could fall still further in the future. Even Americans who hold secure jobs have experienced a dizzying loss in wealth over the past 18 months. Since reaching a peak in 2007, household net worth fell almost $14 trillion, a drop of more than one-fifth. The huge loss in wealth has induced many consumers, including those with secure incomes, to cut back on buying in order to bring their consumption back into line with their long-term ability to spend.

The personal saving rate reached historically low levels in the 1990s and in the past decade for a variety of reasons. The most important was unexpected capital gains, which increased the value of assets held by American households. Roughly two thirds of households own the dwellings in which they live. From the middle of the 1990s until 2006 U.S. house prices reached an unprecedented level compared both with median household income and with prices on other items that are important in household consumption. Stock prices soared from the early 1980s until the beginning of 2000. Only part of this increase was reversed by the sharp fall in stock values between 2000 and 2002. Starting at the end of 2002, stock prices resumed their rise. By the last quarter of 2007, stock values reached a new peak. In that same quarter, the ratio of household net worth to household disposable income reached a post-World-War-II high. 

In the second half of the 1990s and much of the current decade the ratio of U.S. household wealth to household income was rising in spite of the fact that households were saving very little of their incomes. If capital gains on your home and in your stock market portfolio are doing so much of the heavy lifting, why should you make any consumption sacrifice to add to your savings? Asset price deflation turned capital gains into huge capital losses over the past 18 months.  Households now need to save in order to rebuild their wealth holdings.

A second contributor to low household saving in the past two decades was a series of innovations in consumer and mortgage lending. The wider dissemination of credit cards made it easier for households to borrow without any collateral. Innovations in mortgage finance made it easier for people with poor credit records to buy a home and for people with good credit histories to borrow on their homes. These innovations relaxed borrowing constraints that once limited households’ ability to obtain loans when they were temporarily short of funds. Households saw less reason to accumulate or maintain a stash of liquid savings for emergencies. The financial crisis has cut off many households’ access to credit. If they want to protect themselves against future financial emergencies, households must accumulate precautionary savings. They may not be able to rely on credit cards or home loans to tide them over.

If the economy recovers, personal saving will probably decline from its current level, at least modestly. Stock and house prices will rise when the outlook for corporate profits and employment improves. Financial institutions will not forget or abandon the credit innovations introduced over the past two decades, though they will be more cautious about offering credit to many households. Unless we see another big surge in asset prices, however, we should not expect to see the personal saving rate decline to the extraordinarily low rates we saw earlier in this decade.

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            There are a variety of reasons that would make one expect that US household savings will revert over time to their earlier long run average of around 8-10 percent of disposable income. First, households are presently in the process of repairing balance sheets that have been severely impaired by large declines in housing and equity prices. The Federal Reserve estimates that over the past eighteen months household wealth has declined by US$13 trillion, or close to 100 percent of GDP. Second, households are and will remain for some time liquidity constrained as banks tighten lending standards and as reduced home prices preclude households from withdrawing equity from their homes. Third, rising unemployment and declining wages are now heightening job market insecurity and leading to increased precautionary savings.

 

            A rise in US household savings is a healthy long-run development in that it provides a basis for reducing the large US external imbalance and for increasing domestic investment. However, most of the benefits from improved US household saving are presently being largely offset by a substantial and very worrying deterioration in the US public sector’s savings performance. Illustrative of the prospective decline in US public savings are the recent Congressional Budget Office’s estimates of the impact of the Obama budget on the US long-run public finances. The CBO estimates that even once the economy has fully recovered, the US budget deficit will not decline below 4-6 percent of GDP. The CBO is also projecting that the US public debt will increase at its fastest rate in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

 

            From a global economic perspective, one would hope that the prospective large increase in US household savings would coincide with a concerted policy effort in surplus countries, like China and Germany, to increase their countries’ level of household consumption. Were that to occur, the US could address its serious budget deficit problem without fear of contributing to an inadequate level of global aggregate demand.

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The personal saving rate is one of the most misunderstood and misinterpreted pieces of data produced in the NIPAs.  It is designed to show the amount of current “personal” income that is not used for consumption or taxes and it does that.  It does not, however, comport neatly with our common-sense definitions of what constitutes household savings. Here are some of the problems in interpreting the rate:

 

--the “personal” saving rate includes the retained earnings of sole proprietorships and partnerships and nonprofits – hence, universities, foundations and other endowments

 

--the saving rate is affected positively by the rate of inflation – much of the “decline” in saving from the 1980s to the 2000s is due to the drop in inflation – this is a purely mechanical adjustment with no economic content to it

 

--it treats consumer durables and housing differently, even though they are economically equivalent

 

--it treats social security and employer pensions differently even though they are economically very similar

 

--it does not include capital gains. 

 

--it is an aggregate figure and hence can not and should not be interpreted as reporting the effects on “the typical household”  since saving behavior is extremely heterogeneous over the income distribution

 

Having said all that, I think there is some information value in the saving rate.  As I understand the data (aided considerably by some work that Mark Zandi did, linking the SCFs to the Flow of Funds data), what’s happened is that (very) high-income households have cut back on their (conspicuous) consumption and that has reduced overall consumption and hence raised personal saving.  That is encouraging as far as it goes but it does not suggest anything about the typical family or the impact of the stimulus-related tax cuts.  It is just hard to get a lot of information out of the aggregate saving rate.

 

As to whether consumption will rise (the flip side of whether saving will fall), as long as the housing sector is in shambles (and people are either underwater and hence afraid to spend or have little equity and so can’t cash  out funds), as long as unemployment and underemployment stay high, as long as the new credit standards for lending remain extremely high, the broad swath of American households is not going to start consuming more.  That will translate into support for the saving rate, but the real action in saving rate will be swamped by the behavior of high-income households, sole proprietorships, partnerships.  If high income households see their part of the economy turn around (eg, financial markets start rolling again) then saving could drop.

 

 

 

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The return to a positive household savings rate appears to be due chiefly to the "deleveraging" of consumers' balance sheets as they repay debt and probably also to an increase in precautionary savings in the face of recession and rising unemployment. It is impossible to know at this stage whether the savings rate will come down again once these factors have run their course. That will depend on whether individual consumers have undergone a permanent change in psychology.

  While the savings rate remains high, the obvious consequences are:   1) Lower consumer demand in the US and lower GDP growth (since consumption the biggest driver of US GDP). This may have adverse implications for industrial investment and for employment. 2) A continuing sharp reduction in the US current account deficit.  3) An increase in the capacity of the US to finance budget deficits out of domestic savings and a concomitant reduction in its need to rely on China and other foreign creditors to balance the books. 4) Because of 1) a knock-on effect on other economies, particularly those such as Germany, China, Japan and a number of other Asian economies that depend heavily for growth on exports to the US. The only way they could offset the impact would be by stimulating their own domestic consumption. However, only China is trying seriously to do so, and a sustainable reversal in the long-run decline in Chinese household consumption as a percentage of GDP will require radical reforms measures and patience. It will, at best, take years to pay off and it is still unclear whether Beijing - with its fixation on keeping up the growth numbers at all costs - possesses the necessary determination and political will.    

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There are two ways to define savings, the conventional and misleading way (the amount not consumed out of disposable income), and the economically meaningful way (the overall change in wealth that results from the sum of the appreciation of assets plus the amount not consumed out of disposable income). Individual (and aggregate) savings behavior targets the accumulation of wealth, and the latter definition of savings is thus the economically relevant one. If the the value of corporate stocks rises and is expected to remain high, then this form of "savings" reduces the need for the holders of those assets to accumulate savings from their disposable income. Conversely, when stocks, commercial real estate and other physical wealth decline in value (note that residential real estate should not be included as a net addition to personal wealth -- for details, see http://www.voxeu.org/index.php?q=node/3734) individuals must increase their savings from disposable income to compensate for their wealth loss. That is what is happening now. There is no "return to saving," but rather a return to saving from disposable income in reaction to a loss of wealth. Saving, properly measured as the change in wealth, has been very high in the past decade. Personal wealth per capita reached an all time high in recent years in the US as the result of savings (mainly because of rises in the prices of assets).   Looking forward, the best guess is that the saving from disposable income will remain high for some time, for two reasons. First, the Obama Administration's economic policies of high spending, high income taxation, and other anti-growth initiatives (carbon taxation, anti-free trade policies, regulatory overreach, pro-union policies) will keep the stock market and other asset values from rising as they normally would during the recovery from a recession. The low growth in personal wealth will keep savings from disposable income high. Second, slow growth itself increases the targeted savings rate of households, since households looking forward to less growth in their income in the future have to save more today in anticipation of that reduced growth. To the extent that the Administration and Congress succeed in depressing asset values and reducing economic growth, they will no doubt "succeed" in raising the savings rate. A Pyrrhic economic victory, if there ever was one.  

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The famous Paradox of Thrift holds now more than ever: what is good for the individual, and for the economy in the long run -- high saving -- is bad for the economy in the short run, during the current worst-post-30s recession, when we need a boost to demand.   Americans could not have gotten the timing worse.   During the years 1983-2008 the economy grew well, and by the end the first baby boomers had reached their peak earning years.   Yet households’ saving rates fell almost to zero in 2005-07.  Meanwhile the government ran record deficits, reducing national saving even more (in the 1980s and 2000s; the only surpluses were at the end of the 1990s).   It is ironic that the pro-capital orientation to the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 was largely sold as an incentive to increase saving and investment, and yet household saving fell sharply subsequent to both policy changes -- let alone national saving.       (Documented in my “Snake Oil Tax Cuts.”)

 

To answer the question, the saving rate could only rise, from its very low pre-crisis level, even if the timing has been awful.    Presumably the magnitude of the current economic dislocation will teach many people the value of precautionary saving.  We certainly will need further increases in saving as soon as the recession is over. But have we seen a major permanent change in Americans’ anti-saving culture?    Probably not.   Even now, it does not occur to people that it is desirable to pay cash for auto purchases or other consumer durables, or eventually to pay off their mortgage when possible.    Even now, it does not occur to any politicians to change the pro-housing bias in the tax law, by eliminating the tax-deductibility of mortgage interest for example.  Meanwhile, the first baby-boomers have started retiring.   Increasingly, the higher saving rate of those who see retirement looming ahead (many of whom now “have religion”) will be counteracted by the lower saving of those who do retire.

 

The same thing will probably happen in other countries.   Indeed, in Japan, which reached the retirement bulge first, the saving rate has fallen correspondingly. I declare the end of the “global savings glut.”   Real interest rates will have to rise.

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