DECEMBER 2004

Personal Savings Rate Near Record Low

The U.S. Commerce Department reported that the U.S. personal savings rate fell to its second-lowest level ever in October. Households saved 0.2 percent of disposable (after-tax) income, the lowest rate recorded since the U.S. government's monthly savings rate data began in 1959, with the exception of a quirky reading in October 2001 that was related to the terrorist attacks one month earlier.

Should we worry about the low savings rate? Perhaps a bit, but not overly so said Federal Reserve Governor Roger Ferguson in a speech to a trade association back in October. First, some background data are helpful. From the end of World War II until the early 1980s, the U.S. savings rate trended steadily upward, from about 7.5 percent during the 1950s to around 10.5 percent in the early 1980s. Since then, the savings rate has trended steadily downward, and has averaged only about 1.5 percent over the past couple of years. Interestingly, the Federal Reserve also tracks household saving and has found that the decline in the saving rate by households in the top 20 percent of the income distribution accounts for virtually all of the decline in the aggregate personal saving rate since 1989.

The personal saving rate has fallen over the past 20 years for several reasons. One very important reason is the dramatic rise in household net worth attributable to rising equity and real estate prices. Greater wealth reduces the need to save. Since households in the upper 20 percent of the income distribution hold 65 percent of aggregate net worth, it is not surprising that Fed found the entire reduction in the savings rate attributable to this group. Other reasons for the decline in the savings rate include upward revisions in households' expectations about their future incomes. Ferguson notes that "this belief in ‘better economic times ahead' increases the confidence of households about their future income prospects and encourages them to be less thrifty today." This may also explain why the bulk of the change in the savings rate has been observed in the behavior of households in the top 20 percent of the income distribution.

Ferguson argues that the fall in the saving rate is worrisome because it implies that an adjustment may be required in the future to reverse the decline, and, depending upon the speed of the adjustment, it could trigger painful economic consequences. But, a review of the causes of the decline does not suggest that a rapid adjustment is imminent, or even likely. Moreover, economy-wide savings do not have to be wrung solely from the household sector. Indeed, the willingness of foreigners to save for us (i.e. provide funds to build our stock of capital) by investing in the U.S. explains why the U.S. personal savings rate could undergo a sustained decline. Foreigners today fund about 30 percent of our domestic investment. Foreign investment ebbs and flows according to movements in interest rates and the prices of capital goods. Because changes in such prices have historically been orderly, there is no historical basis for expecting (or fearing) sudden and large-scale changes in foreign direct investment. Although we may see upward adjustment in the saving rate as interest rates rise and/or net worth grows more slowly than income, Ferguson doubts that the U.S personal saving rate will return in the near term to the 10 percent rate observed in the early 1980s, or even the 7 percent average rate that prevailed during the 1950s.