Higher Personal Saving: Who Needs It?

Americans have tightened their belts relative to the spendthrift days preceding the financial crisis. Since that time, we have seen a meaningful increase in the U.S. personal saving rate, measured as the combined savings of all households divided by their combined after-tax income. The personal saving rate averaged 3¾ percent over the last year, up from a low of 1 percent in 2005.

Over the near future, there is a downside to higher personal saving. Saving more means spending less, and, with consumer demand accounting for such an important part of the U.S. economy, the economic recovery will not be as strong as it otherwise would be. But, over the longer run, higher saving has important benefits. It provides more funding for investment, which will increase our capital stock and lead to stronger economic growth. In addition, households that save more will attain a more secure financial footing. For many, accumulating wealth is critical to making downpayments on homes, paying for college tuition and big-ticket consumption items, enjoying a decent standard of living in retirement, and weathering unexpected expenses and income disruptions.

How much progress have Americans made toward achieving financial security? We do not actually know because we lack up-to-date comprehensive information about household balance sheets. Moreover, the amount each household needs to be saving differs depending on its circumstances and aspirations. But, we do know that a lot of households lost substantial ground when home and stock prices plunged during financial crisis. According to the 2010 Survey of Consumer Finances, after adjusting for inflation, median household net worth was 28 percent below its level half a dozen years earlier in 2004—before we even hit the frothiest part of the home price boom.

The need to make up for these capital losses is the most obvious reason that many Americans should be doing more saving. But four additional considerations reinforce the point and argue for yet higher rates of savings:

• Incomes have gotten more volatile. My coauthors and I found that the volatility of household income rose nearly 30 percent between 1971 and 2008 as U.S. labor markets became more competitive and dynamic. The harsh labor market conditions of recent years may well have exacerbated this trend. More ups and (particularly) downs in income heighten the importance of households having financial reserves that they can use to buffer cash-flow shocks.
   
• Borrowing will be harder, even over the longer run. Borrowing has traditionally taken the place of having savings in some contexts—credit cards helped households get through hard times and longer-term loans helped households purchase items (including homes) in advance of having the income to do so. But, many households have found it difficult if not impossible to get loans in the extremely tight credit environment of recent years. Conditions should ease with improvements to the economy, but the lessons taken by lenders and regulators from the financial crisis mean such that we are unlikely to see a return to the easy lending standards seen during the credit boom.
   
• We cannot count on our homes to do our saving for us. Rapid house price appreciation during the early- to mid-2000s meant that household net worth was growing without households have to forego consumption (indeed, home price gains allowed them to consume even more). Even though home prices are growing again in many parts of the country, the gains have been modest and we should expect them to continue to be so.
   
• Austerity-driven cuts to social programs are coming.  As policymakers look for ways to reduce growing budget deficits, they are likely to take a whack out of various social programs. Greater retirement saving will be needed to offset cuts to programs helping older Americans, and greater precautionary saving will be needed to replace reductions in transitional benefits.

Many households seem to be having trouble increasing their saving. Only 52 percent of the households participating in the 2010 Survey of Consumer Finances reported having saved over the preceding year—down from more than 56 percent three years earlier. But, Americans do recognize the need to save more: In a recent survey by Absolute Strategy Research, 71 percent of respondents reported that they were “saving too little.”

As part of the coming fiscal negotiations, we should consider ways in which policy might encourage saving by households over the longer run. Existing programs like tax-favored employer-provided plans and college savings accounts are a step in the right direction, but they primarily benefit higher-income tax payers. A variety of interesting ideas have been forward to reach other types of households, including Automatic IRAs and a matched-savings program for households receiving the Earned Income Tax Credit. If we want to achieve broad-based household financial security, we should be exploring these and other options.