July 30, 2005
Which came first: the savings chicken or the deficit egg?
David Altig at Macroblog raises some very thoughtful questions about the relation between the drop in the U.S. saving rate and the current account deficit.
After drifting gradually up from 1955-1984, the U.S. personal saving rate began a steady and very impressive decline. In earlier posts here and here, I joined many others in expressing concerns about this trend, which most recently I believe has made a key contribution to the U.S. current account deficit.
Of course the U.S. saving rate and the current account deficit are related through an accounting identity, and certainly a good story can be told as to why the causation could run in the opposite direction. In a recent post, David Altig raises some doubts about my interpretation, arguing that, if the basic driving factor were as I suggested an exogenous reduction in the U.S. saving rate, then in a large open economy like the U.S., the added efforts by borrowers to obtain funds should drive interest rates up. Altig favors instead an alternative hypothesis that the exogenous development was, as Ben Bernanke also suggested in a speech last spring, an increase in saving by other countries. Altig notes:
A willingness by foreigners to absorb U.S. debt ultimately corresponds to a willingness to export goods and services to the United States. Absent a desire by U.S. consumers to automatically absorb those exports, prices adjust to stoke those desires -- lower interest rates, for example, that do the work of stimulating consumption spending.
There are a variety of ways one might try to measure the relevant interest rate and correct for expectations of inflation. Just to give us something concrete to discuss, the graph on the left plots the 1-year Treasury rate minus the percentage change in the CPI over the preceding 12 months. This "real interest rate" series averages 2.22 from 1984-2005, a very slight increase over the average 1.92 observed from 1955-1983. One could pretend to see, if one were unashamedly snooping about for evidence in support of my interpretation, an increase of a couple hundred basis points in real interest rates when the drop in saving first began in 1984 and again when it accelerated in 1999. On the other hand, one would have to be blind to miss the much bigger drop in real interest rates in 2001, which is where Dave would really like us to focus for his version of the story. I'm nevertheless inclined not to read too much into any of these particular hills and valleys, because I believe that the Federal Reserve has really been a dominant player in all of them, with it (plus the drop in investment demand during the 2001 downturn) being largely responsible for both the drop in interest rates in 2001 as well as the more modest moves up in 1984 and 1999.
I'm inclined to view interest rates as something that could have been used to distinguish these hypotheses, but, given the data, didn't turn out to give us a clear signal one way or the other. However, I'm not willing to call it a draw on that basis, because I think interest rates are forced to play a much more important role in the Bernanke-Altig interpretation than in mine. For my interpretation, one could easily suppose that the failure to observe a more dramatic increase in real interest rates since 1984 is due to the fact that the rest of the world is a pretty big place, capable of absorbing quite a bit of extra U.S. borrowing without driving the world interest rate up very much. So any rise in interest rates that resulted from the drop in U.S. saving might be pretty hard to detect, particularly with other variables changing all the time as well. By contrast, the mechanism whereby the extra global saving is supposed to translate into lower U.S. saving has to operate through a drop in the interest rate. Academic research has typically failed to find a very strong response of consumption spending to interest rates; see for example Motohiro Yogo's very nice paper in the Review of Economics and Statistics in August 2004. To explain the drop in the U.S. personal saving rate since 1984 as having resulted from a change in saving patterns outside the U.S., one would have to claim that a drop in interest rates that is too subtle even to detect from most obvious measures was somehow powerful enough to cause the U.S. personal saving rate to fall from the near-double-digit value it had maintained for a generation down to practically nothing.
In a follow-up post, Altig interprets the housing boom since 2001, as I do, as being driven by low interest rates, and thinks of this as one part of the mechanism whereby the global savings glut has translated into higher U.S. spending. Even if one is prepared to dismiss the role of the U.S. Federal Reserve in lowering interest rates in 2001-2002, this again comes back to the question of whether the drop in U.S. saving is an event you want to date as having begun in 1984 or instead as an event of relatively recent origin.
Here again is the U.S. personal saving rate graph, this time with the addition of a linear time trend fit by least squares to the data for 1984-1997, and then extrapolated to 1998-2004. Bernanke wants to begin the story with the Asian financial crises in 1997. But it appears from this simple exercise that the drop in the U.S. personal saving rate since that date is not in any material way very different from what one would have expected to see on the basis of the trend that was pretty clearly defined well before 1997.
It is true that this drop in the U.S. personal saving rate did not show up as an equally steady increase in the U.S. current account deficit since 1984, owing to the behavior of other components of the accounting identity relating the two, such as corporate saving, investment demand, and the government budget deficit, as further discussed by Altig in his second post. Nevertheless, it seems odd to me to try to tell a story for what happened after 1997 to the series plotted in the graph above that has nothing to do with the factors that produced the long-run trend. And if you do perceive it as a single dominant trend, a contribution of that trend to the current account deficit seems hard to deny.
And furthermore, if you don't think the chicken came first, then there must not be such a thing as an egg.
Posted by James Hamilton at July 30, 2005 07:07 PMdigg this | reddit
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In the comments on http://www.econbrowser.com/archives/2005/07/where_did_that.html I asked, "what happens when the personal savings rate goes negative? That ought to happen in a year or two, if we extrapolate the graph forward." Your new chart seems to show the trend even better.
Posted by: Hal at July 30, 2005 10:07 PM
In theory I suppose it could go negative, Hal, which would mean that households as a group were borrowing from the corporate and foreign sectors, as of course the government would have to be as well. In practice I doubt it would get to that point, despite the impression you'd get from projecting that linear trend a little further.
Posted by: JDH at July 30, 2005 10:28 PM
If you are going to extrapolate, you can't just stop arbitrarily(Sp?), tell us what will happen if it goes negative, and how.
Posted by: Big Al at July 31, 2005 06:57 AM
The most likely scenario for a negative personal saving rate would be for each dollar drop in personal saving to be matched by a dollar increase in the current account deficit, just as has been happening up to this point. The force that could prevent that would be the rise in interest rates that Altig is referring to.
Posted by: JDH at July 31, 2005 07:59 AM
Isn't there a demographic component to personal savings rates? Does the aging of the baby boom figure into this? I think it doesn't quite fit (the baby boomers' peak saving years should be now), but maybe your decline is two phenomena. The early one is the demographic bubble hitting a normal lower-savings age-range in the eighties. The second phase being something else, maybe a wealth effect lowering income-based savings, maybe the baby boomers not beginning to save when we would expect them to for some other reason.
Posted by: Mark Sullivan at July 31, 2005 01:17 PM
Do you (JDH) have an explanation for the falling saving rate?
The Bernanke explanation isn't perfect, but I'm inclined to accept it as a working hypothesis if nobody has a better idea. (I don't buy the direct interest rate effect on consumption per se, but the wealth effect is plausible, and interest rates probably do affect durables consumption to the extent that it is really investment, particularly as it interacts with housing -- e.g. low mortgage rates -> buy house -> buy furniture.)
How's this for an overall explanation: consumption growth is sticky downward but not upward, and people treat capital gains as ordinary income. In the 80s and early 90s, sticky consumption growth was proceeding despite flat incomes. In the late 90s and early 00s, huge capital gains (first in stocks, then in bonds via the mortgage call option, then in housing) caused consumption growth to accelerate.
Posted by: Anonymous at July 31, 2005 04:39 PM
Mark-- Alas, there's no easy demographic story anybody's been able to come up with to fit the facts.
Anonymous-- Really good points! (Does that mean I might know you...?) Certainly if you just want to focus on the late 1990's, the capital gains story would work very nicely. But I feel a little stretched by your effort to patch it up across bull and bear markets to hold together for 20 years. Not saying you're wrong, just feels a little stretched.
I'm really sympathetic to your point that maybe we should just accept a story like yours until we get something better. As for what the alternative might be, perhaps the ideas in Gokhale, Kotlikoff, and Sabelhaus (Brookings Papers on Economic Activity, 1996) merit some further investigation:
Posted by: JDH at July 31, 2005 05:40 PM
It appears to me that the first step down coincides with Volcker's high-interest-rate era, and the steady down-ramp coincides with Greenspan's liquidity-fueled bubble era. In the Volcker era, a mere $100,000 of retirement savings invested in T-bonds would yield $10,000-$15,000 of income without even touching the principal. In the common-stock phase of the Greenspan bubble era, a mere $100,000 in a growth stock fund was expected to grow at 20+% forever. In the current real estate phase, a significant fraction of the populace believes that savings are neither required nor desirable -- that the key to a secure retirement is to not to save but to take on as much mortgage debt as lenders will allow. People who save find themselves in competition with the central banks of Asia, willing to supply seemingly limitless funding to the non-savers in order to subisdize their bloated export manufacturing sectors.
Posted by: jm at July 31, 2005 08:05 PM
(previously "Anonymous" due to a browser problem.
You probably don't know me.)
I admit I'm not quite comfortable with my explanation ("first it was because people had too little income; then it was because they had too much income"). I used to push the sticky consumption growth story back in the mid-90s, but it became more difficult with each new productivity report.
But here's another point: assuming the declining savings rate is "autonomous" rather than externally induced, is it a bad thing? Almost every sensible economist seems to think so, but I will dare to differ. What would the world be like today if the US saving rate had risen for the past decade? The US would be richer, perhaps (though even that I'm not sure of: a higher saving rate stops making you richer when your interest rate hits a floor, as ours almost did 2 years ago; and in the 90s maybe accelerator effects and a Phillips curve shift that might not otherwise have been discovered). But the rest of the world, I imagine, would be in very bad shape. As it is, even with massive demand from the US, Asian countries are experiencing near-deflation, and Europe is struggling. Surely in today's world, a Keynesian stimulus is not a bad thing. With fiscal policy in Japan and the EU hitting constraints, shouldn't we praise the selfless American consumer for sacrificing his own future to help the rest of the world?
Posted by: A Harless at July 31, 2005 08:33 PM
The steady reduction in the savings rate happens to coincide with the introduction of tax advantaged savings vehicles and ever increasing Social Security taxes which might be considered forced savings. Perhaps the individual worker thinks he or she is saving more than enough. This might result in an attitude that it is safe to leverage to the maximum in an ever inflating economy. Later one just sells these assets, covers the loans, and takes the profit. With interest rates falling over this period,
refinancing with cash out being used for consumption, the economy stays hot.
If the asset inflation rate fails to perpetuate itself into the future, debt/worth ratios will catch up to borrowers and their savings won't solve the problem.
There appears to be disconnect in the mind of most between debt and savings which leads many to believe they can borrow themselves into greater wealth.
A similar situation occurred in the 1920's.
Posted by: Anonymous at August 1, 2005 07:57 AM
(remove at to reply by email)
It seems to me the real wealth effect here is paramount.
At least since 1997, US households (and UK ones) enjoyed the benefit of 2 asset price booms-- first stocks (not very important in the UK, but important in the US especially as for many people stock options are a real source of income) and then housing.
As households feel wealthier they spend more of that wealth.
A related factor has been the consistent deregulation of savings markets since the early 80s: it is now far easier to tap housing equity for spending than it was in the late 70s (and more people own homes due to same deregulation).
Since savings are mostly held by the top 10% of households, you can draw a picture where the other 90% of households are using consumer credit markets to draw borrow (shift inter temporal consumption) and even experiencing net negative savings.
A couple of structural factors may underpin all this:
- lower taxes on savings since the early 80s - you can get to your desired level of wealth with less saving
- lower inflation rates - high inflation economies tend to have high savings rates - perhaps due to money illusion on the part of households? (they feel their wealth is being eroded so they save more)
- increased direct connection between households and their savings eg a 401k vs. a traditional defined benefit pension plan. The degree of 'forced saving' is potentially much less in a 401k.
Posted by: John at August 1, 2005 09:12 AM
Quickly going through the Gokhale, Kotlikoff, and Sabelhaus paper at:
I was struck by how stable the sum of household saving and medical expenses has been over the past 50 years. Somewhere in the 15-18% range, but with a 12ish to 4ish split favoring savings in the 50s and the reverse today.
Am I wrong to read this as saying healthcare spending has smashed our piggy bank?
The authors hint at this by calling attention to how much more spending-prone the 64-80 cohort have become and mentioning that some of their income is in the form of benefits like medicare which are in kind, hence always consumed.
Posted by: STS at August 1, 2005 02:01 PM
What will happen is the housing market will top off (happening now), long rates will rise (happening now), refi cash won't be available to the economy. The housing industry will take a hit as speculation drops. Those who need to move, lose an income source or otherwise can't cover the high payment ratios will push prices lower.
It is bad news that this will happen when China is rethinking and acting on its desire to finance US debt. Interest rates may kick up a few points as bond traders start looking into a less rosy interest rate future.
But the dollars China used to bid up bond prices will ultimately be used to bid up commodity prices as it searches the world over for raw materials and energy.
Hence consumers will see interest rates and prices rise, both in commodities and finished goods. But as we know, wages are flat. People will have no savings to cover the gap. And there's no new or developing area where America is globally competitive. So wages are not likely to go up much.
The continuing need for financing will push interest rates up still further as the CAD and fiscal deficits are still huge, the dollar falls further as China realizes its peg is more potentially harmful in capital losses than helpful now with a retrenching, more cautious US consumer.
It's hard to see how it ends with anything but the US standard of living adjusting down to the US's inherent level of global competitiveness.
The question is timing. Economists like Bernanke or Setser can argue for days about trends and conditions but they'll never be able to peer inside the heads of Chinese leaders, who have a big hand in deciding timing here.
However, the process is already beginning (China's dollar peg is now a part of history, interest rates are moving up and the housing market's changing colors right now), and to some extent it's an issue of how fast the communal ostrich gets his head out of the ground and sees the storm (market forces aligning with reality) coming.
That could take a few years, as it's much easier to dump stock than a home, particularly if you live there.
But on the plus side, I can't think, in my 45 years of investing, of a more clear macro-based time to make serious money!
Posted by: Anonymous at August 1, 2005 02:10 PM
STS: I was thinking the same thing. If you disaggregate consumption (from NIPA table 1.5.5, available from the BEA at http://www.bea.gov/bea/dn/nipaweb/Index.asp ) and compare with personal disposable income (NIPA table 2.1, line 26), the only category that has increased persistently and dramatically over time as a fraction of income is "medical care services", and it continues in the years since the study was done. ("Other services" may also have become a problem, but there's little sign of overconsumption anywhere else.)
Posted by: A Harless at August 1, 2005 02:59 PM
Another possible explanation to the decline in personal savings rate starting from early 1980s is financial deregulation starting around 1980, which leads to all sorts of financial innovation which have generally resulted increased access to credit for lower income consumers. I haven't thought through the story carefully, but I suspect somewhere down the line, this story needs to rely on the assumption that not all borrowing/lending is optimal.
Posted by: pat at August 1, 2005 03:37 PM
so if i own stock in a company and that company is hoarding cash, aren't I hoarding cash too?
how/where do these figures appear in the personal savings numbers?
warren buffet calls berkshire hathaway the savings of its owners, isnt this true?
Posted by: DC at August 2, 2005 04:36 AM
It depends entirely where that company has placed its cash. Berkshire has some amount of dollars but also some large percentage in an undisclosed bundle of foreign currency contracts.
So both represent holding "cash", but these days the dollar represents a whole different proposition than most any other currency.
Posted by: Anonymous at August 2, 2005 06:45 AM
STS and Pat-- I agree, institutions for covering medical payments and providing loans look like two of the most promising areas to investigate. But the financial institutions story need not be suboptimal. For years macroeconomists produced studies suggesting that consumers were liquidity constrained, wanting to borrow but unable to do so. Maybe the institutions gradually evolved that finally allowed American households to do what they always wanted. Pat's idea that there may be some other social efficiency issues here is also worth exploring.
Posted by: JDH at August 2, 2005 10:43 AM
DC, the saving here refers to income flows rather than cash per se. But the idea that individuals are counting corporate saving as if it could replace their own personal saving is what Altig is referring to when he talks about piercing the corporate veil.
Posted by: JDH at August 2, 2005 10:46 AM
If consumers used to be liquidity constrained, that pretty clearly is no longer the case. That this isn't *necessarily* suboptimal is logically correct -- certainly I'm glad it's easy to get a 5 figure unsecured line of credit, people do all manner of creative things with those. But a nearly zero personal savings rate seems like strong prima facie evidence of something being suboptimal.
Posted by: STS at August 2, 2005 11:53 AM
Great timing for this post. As of today, savings are now at zero. Next step - negative?
Posted by: CalculatedRisk at August 2, 2005 12:19 PM
STS: Not so obvious to me that zero saving is suboptimal, given that the US is facing an interest rate (2% long-term TIPS yield) lower than its growth rate (3% projected GDP growth). The world is trying to lend us money and offering us very good terms. We don't need to save if we can provide for our future by borrowing abroad and investing the proceeds at a higher return.
Posted by: A Harless at August 2, 2005 06:02 PM
A Harless: Yes, in the aggregate, making 3% on a 2% loan is clearly a win. But in distributional terms, I suspect that the "we" doing the borrowing is not the same "we" doing the investing. But that's a different issue.
Posted by: STS at August 2, 2005 09:10 PM
STS: I agree there are distributional issues, and perhaps many individuals are saving less than they should. But even if the aggregate saving rate were still 10%, many individuals would either face market imperfections or behave irrationally, with some saving too much and some too little. As a nation, zero may be our optimal saving rate right now.
Moreover, a close examination of the terms of trade could lead to the conclusion that there is saving going on now that is not being recorded. Asian countries are selling their products in part by having their central banks offer attractive financing. In order to maintain their trade surpluses, they have to help finance deficit nations like the US. This financing may be significantly reducing the interest rate the US pays internationally. We are, in effect, "saving" the present value of the difference between the current interest rate and the rate that would prevail under a freely floating exchange rate regime. If we were paying higher interest rates but lower prices, the saving would appear in today's national accounts, but over time, the payments would be the same. (Consider as an analogy two 7-year no-down-payment car loans that have different principal and interest rates but the same monthly payment. For the buyer, the result is identical, yet one of the cars would appear superficially to involve less current expenditure.)
Posted by: A Harless at August 2, 2005 09:31 PM
I follow your argument, but it still sounds a bit like those ads that shout "save, save, save!" -- if only you'll come on in and spend, spend, spend!
A lot depends on how the vendor financing skews consumer behavior. Do they go ahead and buy the same car they wanted anyway, and pocket the difference in payments? Or do they just spend the savings on more car?
From a sufficiently abstract point of view, it's almost tautologically true that the savings rate is optimal. After all, if it actually *is* zero, all those market actors can't be wrong.
But if zero saving makes such good sense for households, why have US corporations been saving 1.7% of GDP for the past three years (vs. a 40 year average of -1.2% previously)?
Perhaps the corporate sector is doing all the saving that the US needs to do, so to the extent Americans are shareholders, they are in effect "saving" through corporate balance sheets.
My source for the corporate savings numbers is:
Posted by: STS at August 3, 2005 12:34 AM