FRBSF Economic Letter
2005-30; November 10, 2005
Spendthrift Nation
In September 2005, the personal saving rate out of disposable
income was negative for the fourth consecutive month. A
negative saving rate means that U.S. consumers are spending
more than 100% of their monthly after-tax income. The recent
data are part of a trend of declining personal saving rates
observed for two decades. During the 1980s, the personal
saving rate averaged 9.0%. During the 1990s, the personal
saving rate averaged 5.2%. Since 2000, the personal saving
rate has averaged only 1.9%.
This Economic Letter discusses some of the factors that
appear to be driving the secular decline in the personal
saving rate. These factors include rapid increases in
stock market and residential property wealth, which households
apparently view as a substitute for the quaint practice
of putting aside money each month from their paychecks.
Rapidly rising stock and house prices, fueled by an accommodative
environment of low interest rates and a proliferation
of "exotic" mortgage
products (loans with little or no down payment, minimal
documentation of income, and payments for interest-only
or less) have sustained a boom in household spending
and provided collateral for record-setting levels of household
debt relative to income.
Going forward, the possibility of cooling asset markets
and rising borrowing costs may cause the personal saving
rate to revert to levels which are more in line with
historical averages. While such a development would
act as near-term
drag on household spending and GDP growth, an increase
in domestic saving would help correct the large imbalance
that now exists in the U.S. current account (the combined
balances of the international trade account, net foreign
income, and unilateral transfers).
Measurement issues
 The aggregate personal saving rate computed by the U.S.
Bureau of Economic Analysis (BEA) is the fraction of after-tax
personal income that remains after subtracting various
types of consumption expenditures. Some commentators argue
that the BEA understates the actual saving rate because
the definition of saving omits capital gains on stock portfolios
and real estate which, other things equal, raise the net
worth of households. Others maintain that capital gains
should not be included in the definition because they represent
the return from past saving activity which has already
been counted; assets showing capital gains today were presumably
acquired in the past using the residual of disposable income
minus consumption. Many also note that capital gains on
previously acquired assets can be fleeting if they are
the result of speculative price appreciation, i.e., bubbles.
Finally, even when justified by fundamentals, price appreciation
on previously acquired assets does not create any new productive
assets. The latter are a crucial source of long-run productivity
gains and improved living standards.
Other issues surrounding the measurement of the saving
rate include the method of accounting for employer pension
contributions (which are treated as income even though
these funds are not available for immediate use by households)
and education expenditures by households (which are treated
as consumption even though the spending may augment the
stock of human capital).
 While measurement issues can influence the computed level
of the saving rate on a given date, the basic claim
that household saving activity has been declining
over time remains valid. Other evidence supports the idea that U.S. households
are becoming less saving-oriented and more consumption-oriented. The ratio
of nominal U.S. personal consumption expenditures to
nominal GDP has been trending
up since the early 1980s and is now hovering near an all-time high of 70%
(Figure 1). The U.S. consumption binge has been accompanied
by a parabolic rise in
household debt; the ratio of total household debt to
personal disposable income now stands
at an all-time high of 118% (Figure 2).
Much of the recent run-up in household debt has been
mortgage-related; low interest rates have spurred a refinancing
boom that has allowed consumers
to extract equity
from their homes to pay for a variety of goods and services. According
to data compiled by Greenspan and Kennedy (2005), borrowing
against home equity
generated
an average of $425 billion per year in spendable cash from 2001 through
2004—more than twice the average of $177 billion per year
over the preceding four-year
period.
Explaining the declining
saving rate
 A large body of research has examined the causes and consequences
of the declining personal saving rate (for an overview,
see Marquis 2002). Building on this research, a simple
statistical model of household saving behavior can be constructed
by regressing the personal saving rate on a constant and
three explanatory variables: (1) the ratio of household
stock market wealth to personal disposable income, (2)
the ratio of household residential property wealth to personal
disposable income, and (3) the yield on a 10-year Treasury
bond. The explanatory variables are plotted in Figure 3.
The wealth ratios capture the idea that households perceive
asset appreciation to be a substitute for the practice
of saving out of wage income. The 10-year Treasury yield
is a measure of the perceived return to saving and captures
the fact that asset valuation ratios are strongly influenced
by movements in nominal interest rates (see Lansing 2004).
 Figure 4 plots the U.S. personal saving rate together
with the fitted saving rate from the model. The simple
behavioral
model can account for 89% of the variance in the U.S.
personal saving rate from 1960:Q1 to 2005:Q1. A slightly
improved
fit can be obtained by adding a time trend to the regression
equation. A time trend is a proxy for ongoing credit
industry innovations (growth of subprime lending, home
equity loans,
exotic mortgages, etc.) which have expanded consumer
access to borrowed money and reduced the need for precautionary
saving.
Figure 4 suggests that the decades-long decline in the
U.S. personal saving rate is largely a behavioral response
to long-lived bull markets in stocks and housing together
with falling nominal interest rates over the same period.
Since 2000, the rate of residential property appreciation
has been more than double the growth rate of personal
disposable income. In many areas of the country, the
ratio of house
prices to rents (a valuation measure analogous to the
price-earnings ratio for stocks) is at an all-time
high, raising concerns
about a housing bubble. Reminiscent of the widespread
margin purchases by unsophisticated investors during
the stock
market mania of the late-1990s, today's housing market
is characterized by an influx of new buyers, record
transaction volume, and a growing number of property acquisitions
financed almost entirely with borrowed money.
According to the model, the personal saving rate would
be expected to halt its decline and start moving
up if stock or housing markets sagged, or if long-term
interest
rates jumped, say, due to inflation fears. An increase
in the personal saving rate would slow the growth
of household spending which, in turn, would have negative
implications
for the derived demands of business investment, inventory
accumulation, and business hiring. But, on a positive
note, a pickup in saving activity in the household
sector would
help offset the ongoing deficit spending in the government
sector. A rise in net domestic saving would reduce
the U.S. economy's reliance on foreign capital inflows
as
a source of saving. At present, the U.S. current
account
deficit stands at more than 6% of GDP, implying that
the
U.S. economy must draw in around $3 billion per day
from foreign investors to finance domestic spending.
Policy implications
The decline in domestic saving activity and the accompanying
increase in the U.S. current account deficit have been
labeled "unsustainable" by many analysts and
commentators. To help bring about a smooth, orderly adjustment
of the imbalance, former Federal Reserve Chairman Paul
Volcker (2005) has called for the United States to undertake
a combination of policy measures to "forcibly increase
its rate of internal saving, thereby reducing its import
demand."
Policy options to increase internal saving include: (1)
a decision by lawmakers to restore fiscal discipline
in the government sector, (2) tax reforms that encourage
saving
by shifting the tax base towards consumption, and (3)
the use of monetary policy to lean against asset price
bubbles,
since these stimulate consumption at the expense of saving.
The first two options face hurdles of political feasibility,
while the third remains somewhat controversial; it is
an unsettled question whether central banks should take
steps
to prevent or deflate asset price bubbles (see Lansing
2003 and Rudebusch 2005). There is widespread agreement,
however, that forward-looking central banks should address
the expected impacts of asset price movements on spending,
inflation, and the allocation of resources. Federal Reserve
Chairman Alan Greenspan (2005) recently acknowledged
that: "Our
forecasts and hence policy changes are becoming increasingly
driven by asset price changes."
Conclusion
The decline in the U.S. personal saving rate and the dearth
of internal saving raise concerns for the future. In coming
decades, a growing fraction of U.S. workers will pass their
peak earning years and approach retirement. In preparation,
aging workers should be building their nest eggs and paying
down debt. Instead, many of today's workers are saving
almost nothing and taking on large amounts of adjustable-rate
debt with payments programmed to rise with the level of
interest rates. Failure to boost saving in the years ahead
may lead to some painful adjustments in the future when
many of today's workers could face difficulties maintaining
their desired lifestyle in retirement.
Kevin J. Lansing
Senior Economist
References
Greenspan, A. 2005. "Reflections on Central Banking." Remarks
at a symposium sponsored by FRB Kansas City, Jackson
Hole, Wyoming, August 26.
Greenspan, A., and J. Kennedy. 2005. "Estimates
of Home Mortgage Originations, Repayments, and Debt on
One-to-Four-Family Residences." Federal Reserve
Board, Finance and Economics Discussion Series Paper
2005-41.
Lansing, K.J. 2003. "Should
the Fed React to the Stock Market?" FRBSF Economic Letter 2003-34
(November 14).
Lansing, K.J. 2004. "Inflation-Induced
Valuation Errors in the Stock Market." FRBSF
Economic Letter 2004-30
(October 29).
Marquis, M. 2002. "What's
Behind the Low U.S. Personal Saving Rate?" FRBSF Economic Letter,
2002-09 (March 29).
Rudebusch, G.D. 2005. "Monetary
Policy and Asset Price Bubbles." FRBSF Economic Letter 2005-18
(August 5).
Volcker, P.A. 2005. "An
Economy on Thin Ice." Washington
Post, April 10, page B07.
Opinions expressed in this newsletter
do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
Board of Governors of the Federal Reserve System. Comments?
Questions? Contact
us via e-mail or write us at:
Research Department
Federal Reserve Bank of San Francisco
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