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Tuesday, August 02, 2005

The Paradox of Thrift

The marginal average propensity to save out of income was zero last month.  But wealth is still increasing due to rising home prices.  Because of this households are spending more, an average, than they are earning:

The zero-savings problem, By Chris Isidore, CNN/Money:   … Even as a government report Tuesday showed the national savings rate at zero -- that's right nada -- the rise in the value of homes has given the average U.S. household a net worth of greater than $400,000, according to a separate report from the Federal Reserve.  Household real estate assets have risen by just over two-thirds since 1999, and the run up has enabled consumers to spend more money than they are bringing home in their paychecks. … "[Rising home values] are making people feel they don't need to save," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute. … June was only the second month the rate was at zero since the monthly figure started being calculated in 1959. ...  Strong auto sales in June played a big part in the latest read on the savings rate. The government counts the entire price of the autos purchased during the month, even though most consumers pay for vehicles over time.  But even if that zero savings rate is a bit of a quirk, the trend towards lower and lower savings rates is unmistakable. In May, before the current "employee pricing" offer from automakers, the savings rate was only 0.4 percent, … As recently as 1994, the savings rate was nearly 5 percent. Go back 25 years and double-digit savings rates were the norm. … The low savings rate has kept consumers spending, which in turn has kept the economy growing.  "We've backed ourselves into a very dangerous situation," said Dean Baker, co-director of the Center for Economic and Policy Research. "The economy is dependent on everyone consuming like crazy. If everyone heard my diatribe and said, 'Yeah, we better start saving,' the economy would go into a recession." …

As noted, the cost of higher saving is lower output and employment.  But there is also, presumably, a benefit.  More saving generally leads to more investment because it reduces interest rates, and higher investment leads to more output in the future.  By giving up consumption today even more will be available in the future.  But today, with interest rates already so low, the benefit of increased saving will be less than in the past since there is unlikely to be much stimulus to investment.  Increasing national saving is a worthy goal, and it enhances economic security, but it may lead to reduced output and employment in the present without much compensation in terms of increased production in the future.

[Update: Please see Paradox of Thrift II as well].

    Posted by on Tuesday, August 2, 2005 at 02:52 PM in Economics, Saving | Permalink  TrackBack (0)  Comments (8)


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