For many years, economists and other experts have bemoaned American consumers’ unwillingness to save. Now Americans are saving once again, and observers worry that too much saving translates directly into too little consumer demand. Was consumer saving too low in the past and, if so, why? Is it now too high?
The personal saving rate has soared in recent months. As a percentage of disposable income, the 6.9% rate recorded in May was the highest rate in over 15 years. 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 annual saving rate in 2007.
It may seem puzzling that personal saving would soar at a time of surging unemployment and falling wages and profits. U.S. 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 drop 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 increased rapidly, reaching 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 home equity. 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. But 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. In a future emergency they may not be able to rely on credit cards or home loans to tide them over.
If the economy recovers, personal saving may 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 high-risk 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.
The rise in the personal saving rate no doubt represents a short-term problem. Weak consumer demand has hurt both employment and profits. In the long-run, though, higher personal saving will not only improve the balance sheet of the nation’s households, it should boost the wider economy by making domestic savings available more cheaply to U.S. investors.