Economics of Saving
To Save or Not To Save?
A prominent feature of the past few years has been a marked decline in the savings ratio. The UK Savings ratio has fallen from 13% in 1992 to a record low of 1.1% in September of this year 2008. In the US, saving ratios have fallen by a similar amount.
Many economists suggest that the current financial turmoil reflects a lack of prudence by both consumers and financial institutes - and this is reflected in a falling savings ratio. So why was the US Treasury proposing to use $25 billion to help boost US consumer credit? Is saving good or bad? Should we really be encouraging people to spend more when the economy actually needs a higher saving ratio?
The decline in the savings ratio reflects:
- Rising House and asset prices. As house prices rise people remortgage and feel more confident to spend.
- Increased willingness to borrow and take on debt.
- Higher confidence about economy.
- Relatively low interest rates
Problems of Low Savings Ratios
- The decline in the savings ratio reflects the boom years where people borrowed heavily to finance spending and get on the property ladder at any cost. Rather than save a deposit for a house, people would get a 95% or 100% mortgages. This exacerbated the boom in prices and now is leading to negative equity.
- Consumers have little margin for error. Lower incomes or rising living costs, mean people have little backup.
- Current Account deficit. It is no coincidence that countries with low saving ratios tend to have current account deficits. This is because with low savings, there is high spending on imports. Large current account deficits increase the likelyhood of currency devaluation such as US dollar since 2000 and Iceland this year.
- Is reflected in banks balance sheets. The problem of Northern Rock is that they financed the majority of their mortgages not by savings and customer deposits but by borrowing from other banks.
- Low saving Ratios imply less investment. It reflects a choice to have greater living standards now at the expense of the future.
So Should We save More?In the long term, a higher saving ratio would be desirable. It would help shift the economy from a consumer led growth to a more balanced economic growth. However, a sharp rise in the savings ratio at the present moment would be damaging. Look at the experience of Japan. Japan have a huge current account surplus and huge array of foreign currency reserves. But, it led to stagnant growth for the next 10 years and a national debt of 195% of GDP. (updated)
In a recession, we don't want spending to stop completely. If the savings ratio suddenly shoots up, the decline in consumer spending would be much greater and the recession deeper. Keynes pointed to a phenomena known as the 'paradox of thrift' - In a recession people instinctively save more, but this makes the recession worse.
For the next 12 months, we want to avoid a very painful slowdown. But, when the economy recovers, we need to try and create a situation which encourages a higher level of saving. Above all, we want to avoid another credit led boom. But, just at the moment increasing the savings ratio is not our highest priority.
- To paraphrase the words of Saint Augustine - "Lord, make us virtuous savers - But Not just Yet".
Perma Link | By: T Pettinger | Monday, November 24, 2008
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