The savings rate of a nation can be a tricky statistic, as there’s truly no agreed upon optimal rate by economists. Some say a savings rate that is too large will cause a harmful drop in consumption, while others say a savings rate that is too small might not be able to support a level of investment high enough for long-term growth. Historically, from the mid 1970s until the Great Recession, we saw a gradual decrease of the personal savings rate. However, since 2008, the personal savings rate has been steadily on the rise. Below you can see these trends on a graph of the personal savings rate from 1959 to 2016.
But what does the savings rate mean for an economy? The first thing to look at is the wealth effect. The wealth effect says that an increase in wealth will cause an increase in spending and a decrease in saving. If we look at this at a household level, this makes sense. As one’s largest asset, usually a house, increases in value, they feel more secure with their current financial situation and less worried about having money saved for the future. If they run into problems, they can fallback on their house rather than their savings. This could explain the growing downwards trend from 1975 to 2007. Housing prices increased by 33% in the U.S. from 1980 to 2008. In this same time, the savings rate dropped from ~13% to ~3%. This meant bad news for many people when the housing bubble burst in 2008, as people realized their houses were not worth what they thought, and did not have savings to fall back on.
A low savings rate can be good for the economy in the short run by causing an increase in consumption spending, but in the long run people need their savings to fall back on in times of financial distress. By having a higher personal savings rate, the economy is more pervious to shocks and makes the economy more stable in the long run. There are additional economic benefits to this as well. Not only does a higher savings rate make the economy more stable, but higher savings means a higher level of investment which fuel long term growth.
When we look at GDP it is typically broken up into consumption, net exports, government spending, and investments. Savings is any money not spent into consumption or spent by the government, which economists think of as investments. While consumption is an important part of our GDP, investments is where we really see long term growth. People save and put their money in banks, mutual funds, stocks, bonds, and others, with the idea of getting a return on their investment. With increased personal savings, the level of investments go up and fuel long term growth. Below we will look at the percentage of GDP that is investment over time since 1975.
From this graph we can see that during recessions, investments plummet as people become unsure about the economy. Since the 2008 recession, investments have been creeping back up to normal levels, but are still not where they used to be. By focusing on increasing the personal savings rate, we may be able to achieve a higher investment rate which will lead to more stable overall growth.
Unfortunately many firms are going against this trend. In 2011 68% of working age americans were not using a employer-sponsored retirement program. With the baby boomers retiring and social security dwindling, this spells bad news for the economy as a whole. Retirees will start depending on their working age children, which strains those entering the workforce, many of which already crippled with student loan debt. This in turn makes it harder for younger people to save. The problem is systemic and self-perpetuating, making it important one to solve as early as we can.
This being said, as of late things are looking up. When you look at both graphs, we see an increase in investment and personal savings since 2008. The rise in both of these will help lead to a more stable economy. Saving for the future and not relying on assets important for both the individual, and the economy as a whole. Hopefully we can continue this trend and raise confidence in the economy.